Private Pensions: Participants Need Information on the Risks of  
Investing in Employer Securities and the Benefits of		 
Diversification (06-SEP-02, GAO-02-943).			 
                                                                 
The financial collapse of large firms and the effects on workers 
and retirees has raised questions about retirement funds being	 
invested in employer securities and the laws governing such	 
investments. Pensions are important source of income of many	 
retirees, and the federal government has encouraged employers to 
sponsor and maintain pension and savings plans for their	 
employees. The continued growth in these plans and their	 
vulnerabilities has caused Congress to focus on issues related to
participants investing in employer securities through		 
employer-sponsored retirement plans. GAO's analysis of the 1998  
plan data for the Fortune 1,000 firms showed that 550 of those	 
companies held employer securities in their defined benefit plans
or defined contribution plans, covering 13 million participants. 
Investment in employer securities through employer-sponsored	 
retirement plans can present significant risks for employees. If 
the employees' retirement savings is largely in employer	 
securities in these plans, employees risk losing not only their  
jobs should the company go out of business, but also a		 
significant portion of their savings. Even if employers do not	 
declare bankruptcy, employees are still subject to the dual risk 
of loss of job and loss of retirement savings because corporate  
losses and stock price declines can result in companies 	 
significantly reducing their operations. Under the Employee	 
Retirement Income Security Act and the Securities Acts, the	 
Department of Labor and Securities and Exchange Commission (SEC) 
are responsible for ensuring that certain disclosures are made to
plan participants regarding their investments. Although employees
in plans where they control their investments receive disclosures
under the act regarding their investments, such regulations do	 
not require companies to disclose the importance of		 
diversification or warn employees about the potential risks of	 
owning employer securities. SEC requires companies with defined  
contribution plans that offer employees an opportunity to invest 
in employer stock to register and disclose to SEC specific	 
information about those plans. In addition, in most cases the	 
underlying securities of those plans must be registered with SEC.
However, SEC does not routinely review these company plan filings
because pension plans generally fall under other federal	 
regulation.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-943 					        
    ACCNO:   A04634						        
  TITLE:     Private Pensions: Participants Need Information on the   
Risks of Investing in Employer Securities and the Benefits of	 
Diversification 						 
     DATE:   09/06/2002 
  SUBJECT:   Employee benefit plans				 
	     Employee retirement plans				 
	     Financial instruments				 
	     Financial management				 
	     Information disclosure				 
	     Investments					 
	     Retirement benefits				 
	     Retirement pensions				 

                                                                 
Private Pensions: Participants Need Information on the Risks of  
Investing in Employer Securities and the Benefits of		 
Diversification (06-SEP-02, GAO-02-943).			 
                                                                 
The financial collapse of large firms and the effects on workers 
and retirees has raised questions about retirement funds being	 
invested in employer securities and the laws governing such	 
investments. Pensions are important source of income of many	 
retirees, and the federal government has encouraged employers to 
sponsor and maintain pension and savings plans for their	 
employees. The continued growth in these plans and their	 
vulnerabilities has caused Congress to focus on issues related to
participants investing in employer securities through		 
employer-sponsored retirement plans. GAO's analysis of the 1998  
plan data for the Fortune 1,000 firms showed that 550 of those	 
companies held employer securities in their defined benefit plans
or defined contribution plans, covering 13 million participants. 
Investment in employer securities through employer-sponsored	 
retirement plans can present significant risks for employees. If 
the employees' retirement savings is largely in employer	 
securities in these plans, employees risk losing not only their  
jobs should the company go out of business, but also a		 
significant portion of their savings. Even if employers do not	 
declare bankruptcy, employees are still subject to the dual risk 
of loss of job and loss of retirement savings because corporate  
losses and stock price declines can result in companies 	 
significantly reducing their operations. Under the Employee	 
Retirement Income Security Act and the Securities Acts, the	 
Department of Labor and Securities and Exchange Commission (SEC) 
are responsible for ensuring that certain disclosures are made to
plan participants regarding their investments. Although employees
in plans where they control their investments receive disclosures
under the act regarding their investments, such regulations do	 
not require companies to disclose the importance of		 
diversification or warn employees about the potential risks of	 
owning employer securities. SEC requires companies with defined  
contribution plans that offer employees an opportunity to invest 
in employer stock to register and disclose to SEC specific	 
information about those plans. In addition, in most cases the	 
underlying securities of those plans must be registered with SEC.
However, SEC does not routinely review these company plan filings
because pension plans generally fall under other federal	 
regulation.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-02-943 					        
    ACCNO:   A04634						        
  TITLE:     Private Pensions: Participants Need Information on the   
Risks of Investing in Employer Securities and the Benefits of	 
Diversification 						 
     DATE:   09/06/2002 
  SUBJECT:   Employee benefit plans				 
	     Employee retirement plans				 
	     Financial instruments				 
	     Financial management				 
	     Information disclosure				 
	     Investments					 
	     Retirement benefits				 
	     Retirement pensions				 

******************************************************************
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GAO-02-943

Report to the Chairman, Committee on Banking, Housing, and Urban Affairs,
U. S. Senate

United States General Accounting Office

GAO

September 2002 PRIVATE PENSIONS Participants Need Information on the Risks
of Investing in Employer Securities and the Benefits of Diversification

GAO- 02- 943

Page i GAO- 02- 943 Private Pensions Letter 1

Results in Brief 2 Background 5 More Than Half of the Fortune 1,000
Companies Hold Employer

Securities in Their Defined Contribution and Defined Benefit Plans 8
Investing in Employer Securities Can Present Significant Risks for

Employees* Retirement Savings 14 Current Laws Provide for Disclosures To
Plan Participants, but

Information About Investment Diversification and Risk Is Not Required 19
Conclusion 28 Matter for Consideration 29 Agency Comments 29

Appendix I Scope and Methodology 31 Review of Form 5500 Data 31
Implications of Investing in Employer Securities 33 Regulatory Provisions
for Disclosures 33

Appendix II Bankruptcy and Legal Proceedings of Companies Whose Employees
Participated in Employer- Sponsored Plans 35

Enron 35 Color Tile 36 Southland 36 Lucent 37

Appendix III SEC*s Application of the Securities Laws to Retirement Plans
38

Registration Requirements Under the Securities Act and the Exchange Act 39
Registration and Reporting Requirements Under the Securities

Exchange Act 49 Conclusion 51

Appendix IV Comments from the Department of Labor 52 Contents

Page ii GAO- 02- 943 Private Pensions Table

Table 1: Pension Plan Assets for Fortune 1,000 Companies by Industry 10

Figures

Figure 1: Employer Securities Held by Defined Benefit and Defined
Contribution Plans 9 Figure 2: Holdings of Fortune 1,000 Companies*
Pension Plans 13

Abbreviations

DOL Department of Labor EIN Employer Identification Number ERISA Employee
Retirement Income Security Act ESOP employee stock ownership plans IRS
Internal Revenue Service PBGC Pension Benefit Guaranty Corporation PWBA
Pension and Welfare Benefits Administration SAR summary annual report SEC
Securities and Exchange Commission SMM summary of material modifications
SPD summary plan description

Page 1 GAO- 02- 943 Private Pensions

September 6, 2002 The Honorable Paul S. Sarbanes Chairman Committee on
Banking, Housing, and Urban Affairs United States Senate

Dear Mr. Chairman: The financial collapse of the Enron Corporation and
other large firms and the effects on workers and retirees has raised
questions about retirement funds being invested in employer securities and
the laws governing such investments. Pensions are an important source of
income for many retirees, and the federal government has encouraged
employers to sponsor and maintain pension and savings plans for their
employees. Over 70 million U. S. workers participate in pension and
savings plans, and such plans in 1998 represented about $4 trillion in
retirement savings. The continued growth in these plans and their
vulnerabilities has caused Congress to focus on issues related to
participants investing in employer securities through employer- sponsored
retirement plans.

Enron*s plan participants held a substantial percentage of their
retirement assets in employer securities. Because of the financial losses
suffered by Enron plan participants and the potential for losses to be
incurred by participants in retirement and savings plans that are highly
concentrated in employer securities, you asked us to: (1) determine the
number, types, and dollar amounts of private pension plans that invest in
employer securities; (2) describe why investing in employer securities
through employer- sponsored plans can pose risks to plan participants; and
(3) describe the regulatory provisions for disclosures to participants
owning employer securities through their employer- sponsored plans. You
also asked us to discuss the Securities and Exchange Commission*s (SEC)
administrative determination not to explore the application of the
Securities Act of 1933 and the Securities Exchange Act of 1934 to
retirement plans. This information is presented in appendix III.

To determine the number and types of private pension plans invested in
employer securities, we analyzed plan financial information filed annually
(Form 5500s) with the Department of Labor*s Pension and Welfare Benefits
Administration (PWBA). We analyzed data for the Fortune 1,000 companies
for plan year 1998, which was the most recent year for which

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 02- 943 Private Pensions

complete plan- specific data were available for our review. To calculate
the percentage of pension plan assets held as employer securities, we
first subtracted certain assets that cannot be specifically identified as
employer securities from total plan assets to arrive at *known assets.* To
describe the risks of investing in employer securities through employer-
sponsored plans, we focused on six companies whose private pension plans
according to industry data were heavily invested in employer securities.
We used these companies as examples to illustrate the risks that employees
face when their employer- sponsored plans have high concentrations of
employer securities or real property. For four of the companies we used
publicly available information. We obtained information directly from the
other two companies, but we agreed not to disclose their names. In
addition, as part of our review of regulatory provisions, we interviewed
officials from the Department of Labor (DOL), SEC, and industry
associations about the laws governing employer securities purchases by
retirement plans and the investment information that employers provide to
plan participants.

We conducted our work between February and August 2002 in accordance with
generally accepted government auditing standards. (See app. I for more
details about our scope and methodology.)

Our analysis of the 1998 plan data for the Fortune 1,000 firms showed that
about 550 of those companies held employer securities in their defined
benefit plans or defined contribution plans, covering about 13 million
participants. 1 Our review is not representative of the entire
employersponsored plan universe, but Fortune 1,000 plans covered about 40
percent of the total participants in company plans in 1998. Employer
securities held by these plans totaled $213 billion, or 21 percent of
total known assets. However, when all assets are included, including those
that cannot be specifically identified as employer securities, employer
securities represented 12 percent of total plan assets. DOL*s analysis
showed that for defined contribution plans in 1998, employer securities
represented about 16 percent of total plan assets and less than 1 percent
for defined benefit plans. 2 Manufacturers held 45 percent of the employer

1 Defined benefit plans promise to provide generally a level of monthly
retirement income that is based on salary, years of service, and age at
retirement. The benefits from defined contribution plans are based on the
contributions to and investment returns on individual accounts.

2 DOL*s analysis included all plans with 100 or more participants. Results
in Brief

Page 3 GAO- 02- 943 Private Pensions

stock holdings of the Fortune 1,000 firms. However, such holdings only
represented about 10 percent of the total plan assets held by that sector.
For plans that reported holding employer securities, employee stock
ownership plans (ESOPs), including ESOPs combined with other defined
contribution plans, held the highest concentrations of employer
securities, 3 with these securities making up 58 percent of the total plan
assets of ESOPs. 401( k) type plans held 26 percent of their total assets
in employer securities. 4 Defined benefit plans had less than 5 percent of
their plan assets in employer securities. The highest dollar value of
employer stock holdings were held in companies whose plans combined
components of 401( k) type plans with ESOPs. The amount of employer
securities in private pension plans is likely higher than we reported.
Some companies did not report holding employer securities directly in
their plans, but reported holding plan assets in separate accounts, such
as master trust agreements, that may include employer securities. 5

Investment in employer securities through employer- sponsored retirement
plans can present significant risks for employees. If the employees*
retirement savings is largely in employer securities in these plans,
employees risk losing not only their jobs should the company go out of
business, but also a significant portion of their savings. Employees at
such companies as Enron and Southland experienced such consequences as
both companies declared bankruptcy. Even if employers do not declare
bankruptcy, employees are still subject to the dual risk of loss of job
and loss of retirement savings because corporate losses and stock price
declines can result in companies significantly reducing their operations,
such as in the case of Lucent. However, despite the risks, not every
company whose retirement plans have high concentrations of employer
securities results in employees incurring significant losses. Much depends
on the corporate decisions made by the company*s leadership, which will
determine whether or not the company stays in business. Two companies
whose plans we reviewed had high concentrations of employer securities

3 ESOPs are defined contribution plans that require plan sponsors to
invest plan assets principally in shares of the sponsor*s stock. 4 These
are limited to defined contribution plans with a 401( k) type feature that
are combined with profit- sharing/ thrift savings plans. 5 An employer-
sponsored plan that pools its assets in a master trust with those of other
plans for investment purposes reports only one asset amount on the Form
5500. This amount represents the plan*s interest in the master trust but
provides no information about the master trust*s investments, such as
employer stock.

Page 4 GAO- 02- 943 Private Pensions

holdings, and, other than the volatility of the companies* stock price,
the employees have not suffered substantial losses due to company failure
or downsizing. Finally, some companies help employees mitigate their
losses by balancing plans where risks of loss are borne by employees with
plans where the employer bears such risks. Other plans limit restrictions
they place on diversification of employer contributions. For example,
employees at one company held employer securities through the companies*
profit- sharing plan that was combined with the company*s 401( k) plan,
and the company placed few restrictions on the ability of employees to
diversify employer contributions.

Under the Employee Retirement Income Security Act (ERISA) and the
Securities Acts, DOL and SEC are responsible for ensuring that certain
disclosures are made to plan participants regarding their investments. 6
Although employees in plans where they control their investments
(participant- directed accounts) receive disclosures under ERISA regarding
their investments, such regulations do not require companies to disclose
the importance of diversification or warn employees about the potential
risks of owning employer securities. SEC requires companies with defined
contribution plans that offer employees an opportunity to invest in
employer stock to register and disclose to SEC specific information about
those plans. In addition, in most cases the underlying securities of those
plans must be registered with SEC. However, SEC does not routinely review
these company plan filings because pension plans generally fall under
other federal regulation. (See app. III for SEC*s determination of how
securities law applies to pension plans.) Industry representatives that we
spoke with said that some companies provide plan participants with
investment education, including information about the risks involved in
owning employer stock. However, the investment information the companies
provide is done on a voluntarily basis and varies by company. These
industry officials also said that employers are concerned about the
potential liability associated with making individualized investment
advice available to plan participants. DOL recently issued guidance about
investment advice to make it easier for plans to use independent
investment advisors to provide advice to participants in retirement plans.

6 ERISA is a federal law that sets minimum standards for pension plans
sponsored by private employers.

Page 5 GAO- 02- 943 Private Pensions

This report includes a Matter for Congressional Consideration to require
employers to provide an investment education notice containing basic
information on risk management and the importance of diversification. 7

We provided a draft of this report to the Department of Labor, the
Department of Treasury, and the Securities and Exchange Commission. All
three agencies provided us with technical comments and we incorporated
each agency*s comments as appropriate. DOL also provided written comments
that are reprinted in appendix IV. DOL agreed with our conclusion that
additional investment education is necessary, but stated that the
Secretary of Labor does not currently have the legal authority under ERISA
to require DOL to issue an investment education notice. Consequently, we
changed our recommendation to a Matter for Congressional Consideration to
amend ERISA so that it requires plan sponsors to provide an education
notice.

The U. S. private pension system is voluntary; employers decide whether to
establish a retirement plan and determine the design, terms, and features
of the plan or plans they choose to sponsor. The federal government
encourages employers to sponsor and maintain private pension plans for
their employees and provides tax incentives offered under the Internal
Revenue Code to those who do. Although there is a wide range of specific
plan designs that are permissible under current law, private sector
pension plans are classified either as defined benefit or defined
contribution plans. Defined benefit plans promise to provide, generally, a
level of monthly retirement income that is based on salary, years of
service, and age at retirement. The benefits from defined contribution
plans are based on the contributions to and investment returns on
individual accounts. Most private sector pension plans are defined
contribution plans and this has been true for a number of years. Since the
late 1980s, the number of defined benefit plans has decreased, and most
new pension plans have been defined contribution plans. Many employers,
particularly those with more than 1,000 employees, sponsor both defined
benefit and defined contribution plans. More workers are covered by
defined contribution plans than defined benefit plans, and the assets held
by defined contribution plans now exceeds those held by defined benefit
plans.

7 For information on other issues we raised with Congress, see U. S.
General Accounting Office, Private Pensions: Key Issues to Consider
Following the Enron Collapse,

GAO- 02- 480T (Washington, D. C.: Feb. 27, 2002). Background

Page 6 GAO- 02- 943 Private Pensions

According to DOL, employers sponsored over 673,000 defined contribution
plans as of 1998 compared with about 56,400 defined benefit plans. Defined
contribution plans had about 58 million participants while defined benefit
plans had about 42 million participants.

Defined contribution plans are central to the debate about employee stock
ownership through employer- sponsored plans. Defined contribution plans
include thrift savings plans, profit- sharing plans, and ESOPs. The most
dominant and fastest growing defined contribution plans are 401( k) type
plans, which are plans that allow employees to choose to contribute a
portion of their pre- tax compensation to the plan under section 401( k)
of the Internal Revenue Code. Most 401( k) plans are participant-
directed, meaning that participants make investment decisions about their
own retirement plan contributions within a set of investment choices
selected by the plan sponsor. Employees are usually able to choose from a
menu of diversified fund options when investing their own contributions.
Over the last 20 years, employers have gradually expanded the investment
choices of participants such that most plans are offering over 10
investment choices for participants, including investing in employer
stock. Employees generally have less flexibility over the investments of
the employer contributions to these plans, which frequently take the form
of company stock.

Many employers combine defined contribution plans with a 401( k) feature
and ESOPs or profit- sharing/ thrift savings plans with a 401( k) feature.
8 High concentrations of employer securities are likely to be found when
ESOPs and 401( k) type plans are linked or when 401( k) plans and
profitsharing plans are linked. This is especially true when plans are
combined with ESOPs, which by definition seek to provide for employee
ownership. Moreover, under current law, ESOPs may require participants not
to divest their employer stock holdings until they reach the age of 55 or
10 years of service, essentially restricting participant*s rights to
diversify employer stock holdings.

ERISA has a rule that places a 10 percent limitation on acquiring and
holding employer securities and employer real property for defined benefit

8 A profit- sharing plan is a type of defined contribution plan that
provides for contributions to employees based on employer profits. Profit-
sharing plans provide for employer contributions to participants based on
a definite formula that is generally based on employee compensation. A
thrift savings plan is a defined contribution plan to which employees make
contributions, usually as a percentage of salary.

Page 7 GAO- 02- 943 Private Pensions

plans. The 10 percent limitation states that a plan may not acquire any
qualified employer securities or real property if immediately after the
acquisition the aggregate fair market value of such assets exceeds 10
percent of the fair market value of the plan*s total assets. Employer
securities and real property that appreciate in value after acquisition to
10 percent or more of total plan assets do not have to be sold. Defined
contribution plans other than 401( k) type plans that are not ESOPs are
generally exempt from the 10 percent limitation.

Under ERISA, the Internal Revenue Service (IRS) and DOL*s PWBA are
primarily responsible for enforcing laws related to private pension plans.
PWBA enforces ERISA*s reporting and disclosure provisions and fiduciary
standards, which concern how plans should operate in the best interest of
participants. The IRS enforces requirements concerning how employees
become eligible to participate in benefit plans and earn rights to
benefits. The IRS also enforces funding requirements designed to ensure
that plans subject to such requirements have sufficient assets to pay
promised benefits.

In addition to the types of plans employers provide, some
employersponsored plans have complex designs, such as floor- offset
arrangements. Such arrangements consist of separate, but associated
defined benefit and defined contribution plans. The benefits accrued under
one plan offset the benefit payable from the other. In 1987, Congress
limited the use of such plans significantly invested in employer
securities. However, plans in existence when the provision was enacted
were grandfathered.

Because plan participants are investing in employer securities, securities
law investor protection and disclosure requirements are also important.
Congress enacted the Securities Act of 1933 and the Securities Exchange
Act of 1934 in response to fraud in the securities markets and because of
a perceived lack of public information in the stock markets. The 1940
Investment Company Act, combined with the 1933 act, is the basis for SEC
regulation of investment companies. Companies meeting this description
must register under the Investment Company Act of 1940 and offer their
shares under the Securities Act of 1933. These laws seek to ensure
vigorous market competition by mandating full and fair disclosure and
prohibiting fraud. Under these acts, a primary mission of the SEC is to
protect investors and maintain the integrity of the securities market
through extensive disclosure, enforcement, and education, but the
securities laws also presume individual responsibility for investment
decisions.

Page 8 GAO- 02- 943 Private Pensions

About 550 of the Fortune 1,000 firms in 1998 held employer securities in
their defined contribution or defined benefit plans. Such holdings totaled
over $213 billion and represented 21 percent of the known assets. However,
when all assets are included, including those that cannot be specifically
identified as employer securities, employer securities represented 12
percent of total assets. DOL*s analysis showed that for defined
contribution plans in 1998, employer securities represented about 16
percent of total plan assets and less than 1 percent for defined benefit
plans. Our analysis found that the employer securities holdings were
concentrated in different industries, with the bulk of the holdings held
by manufacturers, which included technology and computer companies. For
plans that reported holding employer securities, most of the employer
securities were concentrated in ESOPs, including ESOPs combined with other
defined contribution plans. A significant portion of employer securities
were also held in the companies* 401( k) type plans. The largest dollar
amounts of employer securities holdings were in companies whose retirement
plans combined their 401( k) type plan with ESOPs. Because some companies
reported holding their plan assets in master trust agreements, the amount
of employer securities holdings in these firms* employer plans are likely
to be higher than we can determine based on 1998 Form 5500 data.

About $213 billion in plan assets held in the employer- sponsored plans of
the Fortune 1,000 were held in employer securities. Almost all of the $213
billion of assets in employer securities were held in the Fortune 1,000*s
defined contribution plans. As shown in figure 1, less than 1 percent of
defined benefit plan holdings were in employer securities and 24 percent
of defined contribution holdings were in employer securities. 9

9 The Fortune 1, 000 defined contribution plans had about $848 billion in
plan holdings and defined benefit plans had about $981 billion in
holdings. More Than Half of the

Fortune 1,000 Companies Hold Employer Securities in Their Defined
Contribution and Defined Benefit Plans

Fortune 1,000 Employer Plans Report Over $213 Billion of Their Assets in
Employer Securities

Page 9 GAO- 02- 943 Private Pensions

Figure 1: Employer Securities Held by Defined Benefit and Defined
Contribution Plans (billions)

Source: GAO analysis of 1998 Form 5500 data.

The Fortune 1,000 sponsored roughly 3,500 defined contribution or defined
benefit plans. Fifty- six percent, or about 2,000 of those plans, were
defined contribution plans and 44 percent, or more than 1,500 plans, were
defined benefit plans. More than 37 million employees were covered by
these plans, which was nearly 40 percent of the total participants in all
company plans in 1998. 10 Twenty million employees participated in one or
more defined contribution plans sponsored by the Fortune 1,000, and over
17 million employees were covered by defined benefit plans.

10 Total participant numbers include double counting.

 Other defined contribution holdings $640.8



Employer securities $212.6 

Other defined benefit holdings $975.9 Employer securities $207.2 or 24
percent of total defined contribution holdings Employer securities $5.4 or
1 percent

of total defined benefit holdings



Page 10 GAO- 02- 943 Private Pensions

Manufacturers had the highest amount of plan assets in employer securities
of the Fortune 1, 000. 11 These companies included computer chip companies
and technology firms, as well as traditional manufacturing companies, such
as tool production and hardware firms. The sector held about $976 billion
plan assets in 1998. As shown in table 1, manufacturing companies held
about 45 percent of the employer securities holdings of the Fortune 1,000
and covered about 41 percent of plan participants of the Fortune 1,000.

Table 1: Pension Plan Assets for Fortune 1,000 Companies by Industry

(Dollars in billions)

Industry Employer securities owned

Percent of all employer securities Total

assets Concentration of

employer securities

(percent) Plan participants

Percent of all plan participants

Manufacturing $94.7 44.54 $975.9 9.7 15,117,571 40.84 Finance, insurance
and real estate 28.9 13.61 152.8 18.9

3,270,537 8. 84 Communication and information 21.0 9. 91 202.9 10.4

2,785,218 7. 52 Retail trade 19.9 9. 36 61.5 32.3 4,508,681 12.18
Utilities 14.2 6. 69 115.2 12.3 1,239,577 3. 35 Services 13.7 6. 45 106.0
12.9 4,362,308 11.79 Industry not reported 9. 0 4.25 102.5 8.8

2,668,234 7. 21 Transportation 6.5 3. 08 75.4 8.7 2,018,620 5. 45
Wholesale trade 2.3 1. 08 14.3 16.1 547,821 1. 48 Mining 1.4 0. 69 15.7
9.4 254,506 0. 69 Construction 0.706 0.33 5.4 13.1 159,462 0. 43
Agriculture 0. 27 0. 01 1. 4 1.9 81,322 0. 22

Total $212.6 100.00 $1,829.3 11.6 37,013,857 100.00

Source: GAO*s analysis of 1998 Form 5500 data. Numbers may not add to
total due to rounding.

Although manufacturers held the highest amount of employer securities of
the 12 sectors, such holdings represented less than 10 percent of the
sector*s total assets. More than 90 percent of the manufacturing sector*s
assets were held in assets other than employer securities, which provided
for some diversification for the industry. The retail sector, which
includes car, food, and clothing sales companies, had the highest
concentration of industry assets in employer securities, with about 32
percent of the

11 We based our industry classifications on those used by DOL in the
Private Pension Bulletin: Abstract of 1998 Form 5500 Annual Reports,
Number 11, Winter 2001- 02. Manufacturers Held the

Highest Amounts of Plan Assets in Employer Securities, but Such Holdings
Were Less Than 10 Percent of the Industry*s Assets

Page 11 GAO- 02- 943 Private Pensions

industries* plans assets in employer securities. Companies in the
industries of mining, construction, and agriculture had the lowest amounts
of employer securities and also covered the fewest number of plan
participants.

Not surprisingly, ESOPs had the highest percentages of plan assets in
employer securities of plans that reported holding such assets. ESOPs,
including ESOPs combined with other defined contribution plans, held over
three- fifths of their known assets in employer securities, while 401( k)
type plans held a little over a quarter of their known assets in employer
securities. Given the requirements that plans must meet to be designated
as an ESOP, it is not surprising that ESOPs and ESOPs with other plan
features hold the highest percentages of employer securities holdings. For
example, ESOPs must be primarily invested in qualifying employer
securities in order for the plan to receive the legal designation of an
ESOP. In addition, in order to ensure that a company*s employees continue
to hold that minimum threshold of company stock, many ESOPs restrict
employees* ability to sell their company stock.

About 220 firms in the Fortune 1,000 sponsored plans that were ESOPs or
ESOPs combined with other defined contribution plans. Those plans held a
total of $143 billion in employer securities. Fifty- eight percent of ESOP
total plan assets were in employer securities. However, certain types of
ESOPs reported higher concentrations than others. For example, standalone
ESOPs* ESOPs that are not combined with other defined contribution plans*
had over 98 percent of plan assets in employer securities. Eighty- four
companies sponsored such ESOPs, covering a little over 1 million
participants.

About 475 companies had defined contribution plans with a 401( k) type
feature and such plans had the highest total dollar amount of employer
securities totaling $172 billion in employer securities. Given that twice
as many companies sponsored a 401( k) type plan as those offering an ESOP,
the high dollar amounts in the 401( k) plans are not unusual. 401( k) type
plans also held significant percentages of plan assets in employer
securities, although not as high as ESOPs. For example, about 324
companies reported sponsoring 401( k) plans that were combined with
profit- sharing/ thrift savings plans, which was by far the most prevalent
type of 401( k) plan offered by the Fortune 1,000 and covered more than
half of the participants participating in 401( k) plans. Twenty- six
percent of those plans* assets were held in employer securities, totaling
about $44 billion. ESOPs Held the Highest

Percentages of Plan Assets in Employer Securities Although 401( k) Type
Plans Had Higher Dollar Amounts, and Plans That Combined Features Held the
Most Employer Securities

Page 12 GAO- 02- 943 Private Pensions

The type of defined contribution plan that had the greatest amount of
employer securities were plans that combined a 401( k) type plan with an
ESOP. About 96 companies sponsored such plans, covering about 2.5 million
employees. These plans held about $93 billion of employer securities and
about 44 percent of all employer securities, which was the highest amount
of employer securities holdings in any of the plan types sponsored by the
Fortune 1,000.

Recent industry data suggest that companies are increasingly sponsoring
plans that combine features of defined contribution plans. For example,
plans that combine ESOPs with a 401( k) type plan are becoming more
prevalent among large, publicly traded companies. Because these plans hold
the most employer securities, many more workers are likely to have a
significant amount of their retirement savings invested in the securities
of their employers. Retirement savings, therefore, may increasingly become
more dependent on employer stock ownership.

Defined benefit plans have smaller percentages of employer securities than
ESOPs or 401( k) type plans. Seventy- five companies of the Fortune 1,000
sponsored defined benefit plans holding employer securities. Such plans
covered 2.3 million participants and held about $120 billion of plan
assets. Employer securities accounted for about 5 percent, or over $5
billion, of the known assets of these defined benefit plans.

Finally, little information is reported on complex plan designs such as
floor- offset arrangements. The 1998 Form 5500 did not require employers
to identify plans with floor- offset arrangements. Furthermore, agency and
industry officials said there is little information on the number of
employer- sponsored plans that have such features.

Because we cannot isolate employer securities held in *master trust
agreements,* our figures on employer securities holdings are likely to be
understated. A master trust agreement is a trust in which assets of more
than one plan sponsored by a single employer or by a group of employers
are held under common control. As shown in figure 2, master trust assets
held the highest percentage of pension plan assets. Amount of Employer

Securities Could Likely Be Higher

Page 13 GAO- 02- 943 Private Pensions

Figure 2: Holdings of Fortune 1,000 Companies* Pension Plans

Note: Total Plan Assets: $1.8 trillion. Source: GAO*s analysis of 1998
Form 5500 data.

The amount of employer securities plans held within master trust
agreements cannot be determined from the 1998 Form 5500. For reporting
purposes, assets of a master trust are considered to be held in one or
more investment accounts that may consist of a pool of assets or a single
asset. In addition, only the account total of the master trust account is
required to be reported on the Form 5500. For example, 29 percent of the
ESOPs sponsored by the Fortune 1,000 reported not holding employer
securities. However, because ESOPs are required by law to hold employer
securities, if such holdings are not reported under the ESOP account they
are likely to be in the master trust agreement accounts. Consequently, our
reported dollar amounts of employer securities are likely to understate
the amount of plan assets held in employer securities. However, DOL
officials said that few Fortune 1,000 companies are likely to hold a
significant percentage of employer securities in master trust agreements.

Recognizing the difficulty of identifying plan assets held in master
trusts, DOL revised the Form 5500 for the 1999 plan filing year. Beginning
with the 1999 filing year, master trusts will file a form 5500 report
along with schedules itemizing the types of assets they hold. According to
DOL officials, this will help ensure adequate reporting on the plan assets
held in master trust investment accounts.

12%  Employer securities

43%  Other assets

45% 

Master trust accounts

Page 14 GAO- 02- 943 Private Pensions

In addition to employer securities holdings in master trust agreements, we
also found basic filing errors in the data. While examples we found may
understate or overstate our concentrations, we were not able to determine
the extent to which such filings errors occurred. For example, we found
filing errors such as the misreporting of employer securities as corporate
debt instruments or stock (other than employer*s own common stock). In one
case, we identified an ESOP that was reported to hold no securities. A DOL
official reviewed this plan and, by examining an accountant*s report that
accompanied the Form 5500, discovered that the plan actually held employer
securities and had made a mistake in filling out the Form 5500* a mistake
that, according to DOL officials, occurs frequently. Furthermore, data
reported on the Form 5500 combines all employer securities into a single
line item. Employer securities held by pension plans may include employer
stock, a marketable obligation such as a bond or note, or an interest in a
publicly traded partnership. Thus, the line item for employer securities
does not accurately reflect the amount of pension plan assets solely in
employer stock.

Investment in employer securities through employer- sponsored retirement
plans can present significant risks for employees. If the employees*
retirement savings is largely in employer securities or other employer
assets, employees risk losing not only their jobs should the company go
out of business, but also a significant portion of their savings. However,
despite the risks, not every company whose employer plan has high
concentrations of employer stock will result in employees incurring
significant losses. Much depends on the decisions made by the company*s
leadership and other factors such as market forces, which determine
whether the company stays in business. Some companies help employees
mitigate their risks by balancing plans where risks of loss are borne by
employees with plans where employers bear such risk. In addition, some
companies help employees limit their exposure to the risk of loss by
allowing employees, if they so choose, to diversify their holdings.

Concentrating their retirement savings in employer securities means that
employees are not only concentrating their assets in a single security,
but are investing in a security that is highly correlated to their work
effort and earnings. Unlike investors, who have ownership in a company but
do not work for the company, employees with high concentrations of
holdings of employer securities in their retirement plans are subjecting
two sources of income, their retirement income and their employment
income, to similar risks. Such holdings directly expose the employee to
the losses of the Investing in Employer

Securities Can Present Significant Risks for Employees* Retirement Savings

High Concentrations of Employer Stock Holdings Can Expose Employees to the
Risk of Losing Their Jobs and Their Retirement Savings

Page 15 GAO- 02- 943 Private Pensions

company they work for much more so than if they worked in another company.
In addition, holding significant proportions of employer securities is
directly at odds with modern financial theory, which says that
diversifying a portfolio offers the benefits of reducing risks at very
limited cost.

Companies prefer to provide company contributions in employer stock for a
number of reasons. Contributions in employer stock puts more company
shares in the hands of employees who some officials believe are less
likely to sell their shares if the company*s profits are less than
expected or in the event of a threatened takeover. Companies also point
out that contributing employer stock promotes a sense of employee
ownership, linking the interest of employees with the company and other
shareholders. In addition, employer stock contributions provide several
tax benefits for companies.

When employees choose to allocate a large portion of their total assets to
their employer*s securities, they are assuming significant risk in order
to achieve a particular expected rate of return. Studies have shown that
employees feel a great deal of loyalty to their company. Because they work
at the company and interact with the company*s managers, they believe they
know the company and feel more comfortable investing in it. In addition,
some employees enjoy being an owner- employee and some believe their
employer*s stock will outperform the overall market over some particular
time horizon. As a result, some employees consider investments in employer
stock through their employer- sponsored plans a safe investment. However,
employees who have significant portions of their retirement savings
invested in employer stock may be exposing themselves to greater financial
risks than necessary. Generally, financial theory indicates that, through
diversification, an investor can achieve a similar expected rate of return
with less risk than a portfolio concentrated in employer securities.

The financial collapse of Enron and other companies, such as Color Tile
and Southland, has highlighted how vulnerable participants are when they
tie their retirement savings to their place of employment. For example,

 Enron employees lost their jobs and a significant amount of their
retirement savings as the company became insolvent. The decline in Enron*s
stock price and its subsequent failure substantially reduced the value of
many of its employees* retirement accounts. Enron*s stock price went from
a high of $80 per share in January 2001, to less than $1 per share in
January 2002. About 62 percent of the assets held in the

Page 16 GAO- 02- 943 Private Pensions

company*s 401( k) consisted of shares of Enron stock. These concentrations
are the result both of employee investment choice and employer matching
contributions with employer stock. In all, about 20,000 employees lost
money because their 401( k) accounts were heavily invested in Enron stock.

 Color Tile employees lost their jobs and their retirement savings when
Color Tile filed for bankruptcy in January 1996. More than 83 percent of
its $34 million in 401( k) plan assets were invested in Color Tile real
property. During the bankruptcy, participant withdrawals or asset
transfers in the 401( k) plan were prohibited until the property was
appraised and sold.

 Southland Corporation employees incurred losses in their retirement
savings. Southland*s pension plans included a 401( k) and profit- sharing
plans. Fifty- eight percent of the assets in Southland*s 401( k) plan was
used to buy 1,100 7- Eleven stores which were then leased back to the
company. When Southland filed for Chapter 11 protection in October 1990,
the 401( k) plan reduced its holdings in 7- Eleven stores to 46 percent of
the assets in Southland*s 401( k) plan. Unlike Enron and Color Tile, the
Southland Corporation emerged from bankruptcy fairly quickly, with
relatively small job loss to its employees.

See appendix II for additional details on of each company. Even without
bankruptcy, employees are still subject to the dual risk of loss of job
and retirement savings because corporate losses and stock price declines
can result in companies significantly reducing their operations. For
example, between December 31, 1999, and July 2001, Lucent Technologies*
stock price fell from $82 to $6 per share and employees* account balances
fell because about 30 percent of the company*s 401( k) plan assets were in
employer securities. For nonmanagement employees, about one- third of
Lucent*s workforce, the employer 401( k) match was in the form of an ESOP
contribution made in employer stock. Employer contributions to Lucent*s
management 401( k) plan were made in the form of employer stock. In
addition, more than 29,000 workers were laid off as a result of the
company*s financial troubles, although the company remains in business.

There are various reasons for companies experiencing financial
difficulties. Although recent company failures have been attributed to
company mismanagement, companies can also experience difficulties because
of such problems as business cycles, market downturns, and Even if
Companies Do Not

Declare Bankruptcy, Employees Are Still Subject to Certain Risks

Page 17 GAO- 02- 943 Private Pensions

declines in a sector of the economy. Depending on the circumstances of the
company, the employer*s stock price can experience a precipitous drop or
it can decline gradually. In either case, substantial holdings of employer
securities in employer- sponsored plans will be affected because of the
company*s financial problems.

Not every company whose employees have high concentrations of employer
securities holdings will experience substantial losses in their plan
assets. Much depends on the corporate decisions made by the company, which
determine whether the company stays in business and the extent to which
the company is forced, if necessary, to reduce operations. In addition,
much depends on the extent that employer*s stock is affected by general
market cycles or market volatility.

Proponents of employer stock investments through employer plans point to
numerous companies that have high concentrations of employer securities in
their employer- sponsored plans and whose participants have not suffered
as a result of such holdings. They state that high concentrations of
employer securities are typically in large companies and that such
companies have demonstrated long- term financial success. They also state
that company performance improves when employees understand the
relationship between their behavior and the accompanying rewards that
accrue to them when they own employer stock.

Two companies whose plans we reviewed had high concentrations of employer
stock holdings and their employees had not suffered substantial losses in
their retirement savings because of company failure or downsizing. Each
company offered defined contribution plans in the form of profit- sharing,
ESOPs, and 401( k) plans. The 401( k) plans at both companies allowed
participants to contribute a portion of their salaries on a pre- tax
basis, and the companies offered a variety of investment fund choices to
give plan participants the flexibility and option of investing their 401(
k) accounts. Overall, more than 57 percent of account balances at one
company and up to 92 percent of the employees* account balances at the
other company are invested in employer stock. At one of the companies, 83
percent of the employees* contributions to the 401( k) plan are invested
in employer stock, and roughly 92 percent of the company*s contribution to
employee accounts is invested in employer stock.

Although each company*s stock price has experienced declines in the recent
overall downturn in the stock market, such declines have not caused their
employees to lose significant portions of their retirement Some Companies
Mitigate

Risks of High Concentrations of Employer Securities

Page 18 GAO- 02- 943 Private Pensions

savings. Company officials said that their company would continue to give
their employees every opportunity to invest in employer stock. In
addition, company officials said that despite the recent downturn in the
market, plan participants have not significantly diversified out of the
employer stock.

Some companies help employees mitigate their exposure to risk by balancing
the types plans where risks of loss are borne by employees with plans
where employers bear such risk. When companies provide defined benefit
plans, employees are likely to receive some level of retirement income
even if they have incurred losses in their defined contribution plans.
With a defined benefit plan, the employer, as plan sponsor, is responsible
for funding the promised benefits, investing and managing the plan assets,
and bearing the investment risk. If the defined benefit plans terminate
with insufficient assets to pay promised benefits, the Pension Benefit
Guaranty Corporation (PBGC) provides plan termination insurance to pay
participant*s pension benefits up to a certain limit. 12 For example,
according to PBGC, Enron sponsored at least five defined benefit plans
insured by PBGC. The largest of these plans covered about 20,000
participants. If one or more of Enron*s defined benefit plans is unable to
pay promised benefits and is taken over by PBGC, vested participants and
retirees will receive their promised benefits up to the limit guaranteed
under ERISA. 13

In addition, some companies help employees mitigate their exposure to the
risk of loss by allowing employees, if they so choose, to diversify their
holdings. Two companies whose plans we reviewed had few restrictions on
their employees* ability to diversify their holdings of employer
securities. For example, one company allowed vested participants at any
age to diversify out of employer stock in the company- contributed portion
of their account. The other company allowed 100 percent diversification of
employee 401( k) contributions, the company match, and the profit sharing
contributions at all times. Several other companies have publicly

12 PBGC was created to insure the pension benefits of participants* in
certain defined benefit plans* whose plans terminate without sufficient
assets to pay all benefits owed. If a defined benefit plan terminates
without sufficient funds to pay all benefits that participants are
entitled to, PBGC takes over the plan and its assets and is responsible
for paying benefits up to limits set by law to participants who are
entitled to receive them.

13 In accordance with ERISA, PBGC benefit payments are subject to a
maximum benefit guarantee. For plans terminating in 2002, the maximum
insured amount payable is $42,954 per year for a worker who retires at age
65.

Page 19 GAO- 02- 943 Private Pensions

announced easing restrictions on when employees can diversify employer
contributions in their accounts. For example, one company announced in
February 2002 that 401( k) plan participants could sell any of their
individual account assets, including their employer match in employer
securities, without restriction. Other companies have also lifted their
restriction that required employees to hold their employer securities from
company contributions until age 50.

ERISA and the Securities Act of 1933 require DOL and SEC to ensure that
appropriate disclosures are made to plan participants and investors
regarding their investments. Under ERISA, companies with
participantdirected individual account plans are to provide plan
participants with certain information and disclosures beyond the general
ERISA reporting requirements. The Securities Act of 1933 requires
companies with defined contribution plans that offer employer stock to
employees to register and disclose to SEC specific information about those
plans. Under the current disclosure requirements of DOL, there is no
requirement that companies disclose to plan participants the risks
involved in investing in employer stock or the benefits of
diversification. Industry representatives we spoke with said that
companies provide employees with investment education and plan information
and in some cases go beyond the minimum requirements. However, because
there is no requirement to educate employees about the investment risks or
the benefits of diversification, investment education can vary by company.
Few employers make more specific individualized or tailored investment
advice available to their plan participants, in part because of concerns
about fiduciary liability. 14 DOL has recently issued guidance about
investment advice, which should help clarify when companies can use
independent investment advisors to provide advice to participants in
retirement plans.

ERISA requires DOL to ensure that appropriate disclosures are made to plan
participants regarding their ERISA- covered pension plans. While companies
automatically make certain information available to plan participants,
there is other information that participants must request in writing.
Certain plans, which are designed to meet specific ERISA provisions, must
provide plan participants with disclosures beyond what is

14 Under ERISA, providing investment advice results in fiduciary
responsibility for those providing the advice. Current Laws Provide

for Disclosures to Plan Participants, but Information about Investment
Diversification and Risk Is Not Required

ERISA Establishes Disclosure Requirements for Plan Participants

Page 20 GAO- 02- 943 Private Pensions

generally required by ERISA. Compliance with this regulation is optional,
but provides employers with a defense to fiduciary liability claims
related to investment choices made by employees in their participant-
directed accounts.

ERISA requires companies to automatically disclose to plan participants
certain information pertaining to their pension plans. These disclosures
are the summary plan description (SPD), summary of material modifications
(SMM), and the summary annual report (SAR). The SPD tells participants
what the plan provides and how it operates. Specifically, the SPD provides
information on when an employee can begin to participate in the plan, how
service and benefits are calculated, when benefits become vested, when and
in what form benefits are paid, and how to file a claim for benefits.
ERISA states that the SPD must be written in a manner *calculated to be
understood by the average plan participant* and must be *sufficiently
comprehensive to apprise the plan*s participants and beneficiaries of
their rights and obligations under the plan.* In other words, the
disclosed information should be understandable and allinclusive so
participants can have useful information that will aid them in effectively
understanding their pension plans. New employees must receive a copy of
the most recent SPD within 90 days after becoming covered by the plan.

In addition to the summary plan description, plan participants are
entitled to receive a summary of material modifications. The summary of
material modifications discloses any material changes or modifications in
the information required to be disclosed in the SPD. Plan administrators
must furnish participants with an SMM within 210 days after the close of
the plan year in which the modification was made.

Participants must also receive a summary annual report from their plan*s
administrator each year. The summary annual report summarizes the plan*s
financial status based on information that the plan administrator provides
to DOL on its annual Form 5500. Generally, the SAR must be provided to
participants no later than 9 months after the close of the plan year.

Plan participants may also request additional information about their
plans. If plan participants wish to learn more about their plan*s assets,
they have the right to ask their plan administrator for a copy of the
plan*s full annual report. In addition, a participant can request a copy
of his or her individual benefit statement, which describes a
participant*s total accrued and vested benefits. Plan participants can
also request the documents and Disclosures on Pension Plans

Required under ERISA

Page 21 GAO- 02- 943 Private Pensions

instructions under which the plan is established or operated. This
includes the plan document, the collective bargaining agreement (if
applicable), trust agreement, and other documents related to the plans.

Under the 404( c) regulation, participants receive certain disclosures
pertaining to the plan and its investment options. 15 The regulation is a
benefit to plan participants because it allows them to receive additional
disclosure beyond what is generally required under ERISA. The purpose of
these informational requirements is to *ensure that participants and
beneficiaries have sufficient information to make informed investment
decisions.* 16 The regulation also benefits employers who comply with its
requirements, because it exempts them from fiduciary liability related to
the investment choices made by their employees in their
participantdirected accounts.

The regulation specifically requires that the plan administrator
automatically provide the plan participant with (1) an explanation that
the plan is a 404( c) plan and that the fiduciary will be relieved of
liability; (2) a description of investment alternatives; (3) the
identification of any designated investment managers; (4) an explanation
of circumstances under which the participant may give investment
instructions or limitations; (5) a description of transaction fees and
expenses; and (6) the name, address, and telephone number of the fiduciary
to contact for further information regarding these disclosures. In
addition, for a plan with employer stock, plan administrators are to
provide all voting information and the procedures for ensuring the
confidentiality of participant investment transactions, as well as a
prospectus immediately before or after the initial investment.

Plan participants can also request certain plan information. This includes
(1) a description of the annual operating expenses of the plan*s
investment alternatives, including any investment management fees; (2)
copies of any prospectuses, financial statements and reports, and other
information furnished to the plan relating to investment alternatives; (3)
the list of assets comprising the portfolio of each investment option that
holds plan assets; (4) information about the value of shares or units in
investment

15 29 C. F. R. 2550. 404c- 1. ERISA 404( c) generally relieves employers
of liability for fiduciary error when the employer permits participants to
exercise control over their accounts. 16 Final Regulations Regarding
Participant Directed Individual Account Plans, 57 Federal Register 46,906,
46,909- 10 (Oct. 13,1992) (codified at 29 C. F. R. 2550. 404c- 1).
Regulation under Section

404( c) of ERISA Establishes Additional Disclosure Requirements

Page 22 GAO- 02- 943 Private Pensions

alternatives available along with information concerning past and current
investment performance of each alternative; and (5) information pertaining
to the value of shares or units in investment alternatives held in the
participant*s account.

Employers choose whether to provide disclosures under the regulation.
Those who comply with the regulation are afforded certain protections from
their fiduciary liability.

 First, compliance exempts plan fiduciaries from responsibility for
investment decisions of employees when employees exercise control over
their investments. However, the regulation establishes conditions
employers must meet in order to be exempted from fiduciary liability
related to investment choices made by participants. Employers must provide
employees with the opportunity to choose from a broad range of investment
options; allow employees to transfer the assets in their accounts into and
out of the various plan investment options with a frequency that is
reasonable in light of the market volatility of those investment options;
and the plan*s investment options must permit employees to diversify their
investments. If the plan meets the requirements of the regulation and a
participant fails to diversify his or her account and invests all the
account assets in his or her employer*s stock, the employer will be able
to assert that the company is not responsible for any financial losses
incurred by the participant because the company has complied with the
regulation.

 Second, participants that manage the investments of their accounts are
not considered to be fiduciaries. The employer is also not subject to
potential fiduciary liability for the participant*s investment decisions.

Plan sponsors are not relieved of all fiduciary responsibilities by
complying with the regulation. For example, they remain responsible for
the prudent selection of investment alternatives and monitoring plan
investments on an ongoing basis.

Because defined contribution plans require that employees assume the
investment risk, securities law protections applicable to investors are
relevant to plan participants. Employees in participant- directed plans
might be given the choice of investing in securities, including employer
securities, as well as a variety of mutual funds. The securities laws
require disclosure of information about investment objectives,
performance, investment managers, fees, and expenses of mutual funds and
information Compliance with Section

404( c) Regulations of ERISA Is Optional

Under the Securities Act Certain Pension Plans Are Required to Register
with SEC

Page 23 GAO- 02- 943 Private Pensions

about the business objectives, financial status, and management of
companies that are issuing securities. However, distribution of these
disclosure materials to plan participants making investments may depend on
employer compliance with requirements of ERISA*s 404( c) regulations. In
addition, interests in certain pension or profit- sharing plans are
securities subject to the registration and antifraud requirements of the
Securities Act of 1933 (1933 act), which we discuss in further detail in
appendix III. Pension or profit- sharing plans that have the investment
characteristics of securities are required to register under the 1933 act.
Interests of employees in plans are securities where the employees
voluntarily participate in the plan and their individual contributions can
be used to purchase employer stock. This generally includes 401( k) salary
reduction plans and savings plans where participant contributions are used
to purchase employer securities. If employer securities are offered and
sold to employees pursuant to a pension plan, those securities must be
registered also.

The 1933 act requires registration of securities being offered for sale to
the public. The registration statement, which SEC makes publicly
available, must disclose the basic business and financial information for
the issuer with respect to the securities offering. SEC requires companies
that offer securities to their employees under any employee benefit plan
to register those securities on Form S- 8. SEC generally makes the
companies* Form S- 8 publicly available, but does not routinely review
these forms. The SPD may be used to satisfy the prospectus delivery
requirement applicable to Form S- 8. 17 However, the SPD is not filed with
the SEC as part of the Form S- 8. Although ERISA requires SPDs to be
provided to participants, DOL no longer requires the SPD to be filed with
the Department.

SEC generally limits its review of corporate filings to ensure that the
initial registration of the security and other reporting comply with its
disclosure requirements. As part of its interpretive responsibility, SEC
has no requirement in law or regulation to verify the accuracy or
completeness of the information companies provide. SEC*s review of
corporate filings may involve a full review, a full financial review, or
monitoring of certain filings

17 Rule 428 under 17 C. F. R. Section 230.428 specifies what companies
must deliver to plan participants to satisfy the prospectus delivery
requirement of Form S- 8. SEC Makes Registration

Documents Available to the Public, but Does Not Routinely Review Them

Page 24 GAO- 02- 943 Private Pensions

for specific disclosure requirements. 18 In our work at SEC, we found that
its ability to fulfill its mission has become increasingly strained, due
in part to imbalances between SEC*s workload and staff resources. 19 Like
other aspects of SEC*s workload, the number of corporate filings has grown
at an unprecedented rate. SEC*s 2001 goal was to complete a full financial
review of an issuer*s annual report required by the Exchange Act in 1 of
every 3 years* a review goal of about 30 to 35 percent of these annual
reports per year. However, SEC only completed full or full financial
reviews of 16 percent of the annual reports filed or about half of its
annual goal in 2001. In this post- Enron environment, SEC plans to
reconsider how it will select filings for review and plans to revise its
approach for allocating staff resources to conduct those reviews.

The SEC does not routinely review companies* Forms S- 8 for completeness
or accuracy and has not routinely reviewed these filings for the last 20
years, according to SEC staff. 20 SEC staff said that while they track the
total number of Form S- 8 filings each fiscal year. They do not separately
track the number of filings for different types of plans, such as 401( k)
plans or stock option plans. SEC staff can, however, take action against
an issuer if it discovers that a Form S- 8 does not comply with applicable
law. For example, SEC has taken enforcement actions against companies that
have abused the S- 8 short form registration. In the late 1990*s, some
companies had used Form S- 8 filings inappropriately for raising capital
and not for compensatory offerings for employee plans.

Recently, SEC has placed increased emphasis on clear, concise and
understandable language in prospectuses. SEC requires that in drafting
disclosure documents, registrants should aim to write clearly and to
provide for more effective communication. SEC implemented the plain
English requirement for certain parts of the 1933 act prospectus. For

18 A full review involves an in- depth examination of the accounting,
financial, and legal aspects of an issuer*s filing. A full financial
review involves an in- depth accounting analysis of an issuer*s financial
statements and management*s discussion and business plan disclosure.

19 See U. S. General Accounting Office, Human Capital: Major Human Capital
Challenges at SEC and Key Trade Agencies, GAO- 02- 662T (Washington, D.
C.: Apr. 23, 2002). 20 According to SEC*s Interpretive Release No. 6188,
SEC made revisions to the Form S- 8 and revised its procedures for making
it effective. The Commission believed that the public interest would be
better served by prompt effectiveness of such filings without the delay
necessitated by the low review priority given to them. SEC substantially
revised Form S- 8 in 1990.

Page 25 GAO- 02- 943 Private Pensions

example, with respect to mutual funds, SEC*s rules require that the
prospectus should contain information appropriate for an average or
typical investor who may not be sophisticated in legal or financial
matters.

ERISA was enacted in 1974 within the context of defined benefit pension
plans where employers make plan investment decisions; consequently, ERISA
does not require plan sponsors to make investment education or advice
available to plan participants. Moreover, according to DOL officials,
employers that sponsor pension plans are not required to provide
educational materials on retirement saving and investing. Hence, employers
are not required to provide information about the risks involved in
investing in employer securities and the importance of diversification to
a prudent investment strategy. Additionally, under ERISA, providing
investment advice results in fiduciary responsibility for those providing
the advice, while providing investment education does not.

Industry officials that we spoke with said that many companies provide
employees with investment education and plan information. Plan
participants are given a number of investment education materials, such as
newsletters, quarterly reports on participant accumulations, and annual
reports with benefit projections. Companies also provide information to
employees about their investment plan options. Employees are also provided
information explaining the value of diversification. Furthermore,
according to these officials, diversification is a theme that they
emphasize in their investment education programs.

Investment education varies by company in part because ERISA has no
requirements about informing participants about investment risks or
diversification. Industry officials that we spoke with told us that many
companies voluntarily provide some investment education to plan
participants and that they do so because education is needed to improve
employees* abilities to manage their retirement savings. However, because
there is no standard format for investment education, companies provide
employees with information that they believe is important to managing
their retirement savings accounts and this information varies by
employers.

DOL does not monitor the type of investment education provided to plan
participants and little is known about the accuracy and usefulness of the
Investment Education Is

Not Required, but Is Sometimes Provided in Addition to Disclosures

Page 26 GAO- 02- 943 Private Pensions

investment education programs and materials provided to employees. SEC
provides broad investor education, only to the extent that it affects all
investors, but it does not specifically target pension plan investors. 21

Industry officials also said that providing investment education to
employees does not necessarily mean that companies are providing
information on the risks of holding employer securities. These officials
said that telling plan participants that an investment may be risky or
that an employee*s holdings are risky could be interpreted as providing
investment advice. Consequently, companies provide general information
about the benefits of diversification, but little information about the
risk of holding certain investments, such as employer stock.

Some studies also indicate that the type and amount of investment
education varies by company. For example, one study by a benefits
consulting firm found that 24 percent of their respondents reported that
their companies offered investment information on an as- needed basis, and
11 percent reported that their companies offered no information at all.
The remaining respondents said their companies offered detailed
information, either on an ongoing basis (33 percent), or at plan
enrollment and annually thereafter (32 percent).

Industry officials told us that many companies do not offer investment
advice mainly because of fiduciary concerns about the liability for such
advice if it results in losses to the participant, even if the investment
advisor is competent and there is no conflict of interest. Companies also
have fiduciary concerns about the ability to select and monitor a
competent investment advisor under ERISA*s prudence standard. 22
Additionally, ERISA currently prohibits fiduciary investment advisors from
engaging in transactions with clients* plans where they have a conflict of
interest, for example, when the advisors are providing other services such
as plan administration. As a result, these investment advisors cannot

21 Within SEC, its Office of Investor Education is responsible for
disseminating information to educate the investing public about the
advantages and risks associated with investing. In this capacity, SEC
seeks to protect investors by first providing them with pertinent
information to assist in making investment decisions appropriate for their
circumstances. SEC provides web- based links to other federal, state, and
related investor education web sites that contain materials or information
useful to investors.

22 ERISA*s prudence standard requires a fiduciary to act as a prudent
person experienced in such matters would in similar circumstances.

Page 27 GAO- 02- 943 Private Pensions

provide specific investment advice to plan participants about their firm*s
investment products without approval from DOL.

Industry officials we spoke with said that more companies are providing
plan participants informational sessions with investment advisors to help
employees better understand their investments and the risk of not
diversifying. They also said that changes are needed under ERISA to better
shield employers from fiduciary liability for investment advisors
recommendations to individual participants. In 1996, DOL issued guidance
to employers and investment advisers on how to provide educational
investment information and analysis to participants without triggering
fiduciary liability. 23 This guidance identifies and describes certain
categories of investment information, and education employers may provide
to plan participants. These categories are (1) information about the plan,
(2) general financial information, (3) information based on *asset
allocation models,* and (4) *interactive investment materials.* According
to DOL, these investment education categories merely represent examples of
investment information and materials that if furnished to participants
would not constitute the rendering of investment advice.

DOL has recently issued guidance about investment advice, which should
help clarify when companies can use independent investment advisors to
provide advice to participants in retirement plans. In 2001, DOL issued
Advisory Opinion 2001- 09A. This Advisory Opinion was a response to an
application for exemption filed on behalf of SunAmerica Retirement
Markets, Inc. (SunAmerica) with DOL, which sought exemption from the
prohibited transactions restrictions. 24 DOL determined that SunAmerica*s
proposed method of issuing investment advice directly to plan participants
would not violate the prohibited transaction provisions of ERISA. DOL*s
ruling allows financial institutions to provide investment advice directly
to retirement plan participants when the advice is based on the computer
programs and methodology of a third party, independent advisor; therefore
eliminating conflicts of interest. DOL officials said that they hope the
Advisory Opinion ruling helps plans to sponsor the type of nonconflicted
investment advice they are allowed to provide plan participants.

23 Interpretive Bulletin 96- 1. 24 The Advisory Opinion prohibited
fiduciary investment advisors from engaging in transactions with clients*
plans where they have a conflict of interest.

Page 28 GAO- 02- 943 Private Pensions

The Enron collapse serves to illustrate what can happen under certain
conditions when participants* retirement savings are heavily invested in
their employer*s securities. When the employer*s securities constitutes
the majority of employees* individual account balances and is the primary
type of contribution the employer provides, employees are exposed to the
possibility of losing more than their job if the company goes out of
business or into serious financial decline* they are also exposed to the
possibility of losing a major portion of their retirement savings. We
presented other concerns about what can happen to employees* retirement
savings under certain conditions to the Congress in our testimony in
February 2002. 25 In addition to the issues of diversification and
education, we suggested that further restrictions on floor- offset
arrangements may be warranted.

As our analysis shows, it is not unusual to find concentrations of
employer securities in the plans of large firms such as the Fortune 1,000
that cover a significant portion of employees. To the extent these defined
contribution plans become the primary component of employees* retirement
savings; these plans are most subject to risk of loss, and employees and
policy makers should be concerned about the risks employees face by
holding large portions of their retirement savings in employer securities.
This is especially important as fewer companies are offering defined
benefit plans that could provide some level of guaranteed retirement
savings to employees even if they incur substantial losses in their
defined contribution plans.

Current ERISA disclosure requirements provide only minimum guidelines that
companies must follow on the type of information they provide to plan
participants. In addition, there is little government oversight of the
information companies provide to plan participants. Consequently, the type
and amount of information plan participants are receiving about their
investments is not known. Improving the amount of disclosure provided to
plan participants could help ensure that plan participants are at least
getting some minimum level of information about investing, especially with
regard to employer securities. In addition, providing plan participants
with disclosures on the risks of holding employer securities and the
benefits of diversification in mitigating employees* losses may help

25 See U. S. General Accounting Office, Private Pensions: Key Issues to
Consider Following the Enron Collapse, GAO- 02- 480T (Washington, D. C.:
Feb. 27, 2002). Conclusion

Page 29 GAO- 02- 943 Private Pensions

employees make more informed decisions regarding the amount of employer
securities they hold in their retirement plans.

To address the lack of investment education and information provided to
participants, the Congress should consider amending ERISA so that it
specifically requires plan sponsors to provide participants in defined
contribution plans with an investment education notice that includes
information on the risks of certain investments such as employer
securities and the benefits of diversification.

We provided a draft of this report to the Department of Labor, the
Department of the Treasury, and to the Securities and Exchange Commission
for review and comment. We received written comments from the Department
of Labor that are reprinted in appendix IV. DOL, SEC, and the Department
of Treasury also provided technical comments on the draft. We incorporated
each agency*s comments as appropriate.

Included in the draft for DOL*s review was a recommendation to the
Secretary of Labor to direct the Assistant Secretary, Pension and Welfare
Benefits Administration, to require plan sponsors to provide participants
in defined contribution plans with an investment education notice. DOL
agreed with our conclusion that additional investment education is
necessary, but stated that the Secretary of Labor does not currently have
the legal authority under ERISA to require an investment education notice.
Consequently, we changed our recommendation to a matter for consideration
for the Congress to amend ERISA so that it requires plan sponsors to
provide an education notice.

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days
after its issue date. We are sending copies of this report to the
Secretary of Labor; the Secretary of the Treasury; and the Chairman,
Securities and Exchange Commission. We will also make copies available to
others on request. In addition, the report will be available at no charge
on the GAO Web site at http:// www. gao. gov. Matter for

Congressional Consideration

Agency Comments

Page 30 GAO- 02- 943 Private Pensions

If you have any questions concerning this report, please contact Barbara
Bovbjerg at (202) 512- 7215, Richard Hillman at (202) 512- 8678, George
Scott at (202) 512- 5932, or Debra Johnson at (202) 512- 9603. Other major
contributors include, Joseph Applebaum, Tamara Cross, Rachel DeMarcus,
Jason Holsclaw, Raun Lazier, Carolyn Litsinger, Gene Kuehneman, Alexandra
Martin- Arseneau, Corinna Nicolaou, Vernette Shaw, Roger Thomas, and
Stephanie Wasson.

Sincerely yours, Barbara D. Bovbjerg Director, Education, Workforce

and Income Security Issues Richard J. Hillman Director, Financial Markets

and Community Investments

Appendix I: Scope and Methodology Page 31 GAO- 02- 943 Private Pensions

To determine the number and types of private pension plans invested in
employer securities, we analyzed plan financial information filed annually
(Form 5500s) with the Internal Revenue Service and Pension and Welfare
Benefits Administration( PWBA). The annual Form 5500 report is required to
be submitted annually by the administrator or sponsor for any employee
benefit plan subject to Employee Retirement Income Security Act (ERISA) as
well as for certain employers maintaining a fringe benefit plan. It
contains various schedules with information on the financial condition and
operation of the plan. PWBA provided us with a copy of the complete 1998
electronic Form 5500 database and a preliminary 1999 electronic database
for Form 5500s for our analysis. The 1998 database contained information
from over 215,000 Form 5500 reports. We did not independently verify the
accuracy of the Form 5500 databases. In addition, the data we analyzed
were accurate only to the extent that employers exercised appropriate care
in completing their annual Form 5500 reports.

We decided to focus our analysis on the largest 1, 000 corporations. In
order to determine the Fortune 1,000 companies for our review, we used the
*Fortune Magazines* listing of the largest corporations in the United
States, which determines the largest corporations by looking at
corporations* revenue during the preceding year. 1 After determining the
1,000 largest corporations, we analyzed data for the Fortune 1,000
companies (the corporations and their subsidiaries) for plan year 1998,
which was the most recent year for which complete plan- specific Form 5500
data were available for our review.

In order to review the Fortune 1,000*s Form 5500s, we matched the Fortune
1,000 companies to their pension plans on the basis of their Employer
Identification Numbers (EINs). An EIN, known as a federal tax
identification number, is a nine digit number that the IRS assigns to

1 All companies on the list must publish financial data and must report
part or all of their figures to a government agency. Private companies and
cooperatives that produce a 10- K are, therefore, included; subsidiaries
of foreign companies incorporated in the United States are excluded.
Revenues are as reported, including revenues from discontinued operations
when they are published on a consolidated basis (except when the divested
company*s revenues equal 50 percent or more of the surviving company*s
revenues on an annual basis). The revenues for commercial banks and
savings institutions are interest and noninterest revenues. Such figures
for insurance companies include premium and annuity income, investment
income, and capital gains or losses, but exclude deposits. Revenues
figures for all companies include consolidated subsidiaries and exclude
excise taxes. Appendix I: Scope and Methodology

Review of Form 5500 Data

Appendix I: Scope and Methodology Page 32 GAO- 02- 943 Private Pensions

organizations. 2 We used several methods to identify the EINs associated
with the Fortune 1,000. We started with a list of EINs for over 500
companies that was provided to us by the Pension Benefit Guaranty
Corporation (PBGC). To identify the EINs for the remaining companies we
searched public filings, including 10- K statements filed with the SEC,
using the search tools available through nexis. com. Where we could not
find a company*s EIN and for companies whose EIN was not associated with a
Form 5500, we conducted a text search of the electronic Form 5500 data to
find plans sponsored by these companies. Additionally, we used 10- K
filings for the Fortune 1,000 companies to identify major subsidiaries
that might have their own pension plans. We conducted further text
searches of the electronic Form 5500 data to identify pension plans for
these subsidiaries. Our analysis includes information for subsidiaries to
the extent we were able to identify them during our review. We eliminated
from our analysis any Form 5500 returns that did not report end- of- year
assets and also eliminated plans that did not report end of year
participants. This resulted in a database containing the information of
3,480 Form 5500 returns filed by 996 of the Fortune 1,000 companies or
their subsidiaries. Our totals for the number of plan participants include
double counting of participants because some individuals may participate
in more than one pension plan sponsored by the same employer.

Because master trust holdings accounted for 45 percent of the assets held
by the Fortune 1,000 employer- sponsored plans, we tried to identify
employer securities held outside of master trusts. To calculate the
percentage of pension plan assets held as employer securities, we first
subtracted master trust assets from total plan assets to arrive at *known
assets.* We then calculated the percentage of known assets comprised of
employer securities to determine the percentage concentration of plan
assets in employer securities. Plans holding assets in master trust
accounts reported only the total asset value of these holdings and did not
itemize or otherwise identify any the individual investments held by a
master trust for 1998 Form 5500 filings. As such, we were unable to
determine what fraction of that 45 percent consisted of employer
securities. However, we analyzed preliminary 1999 Form 5500 data for
master trust accounts and found that some of the assets reported by these
master trust accounts were holdings of employer securities.

2 The IRS uses the number to identify taxpayers who are required to file
various business tax returns as well as the Form 5500. EINs are used by
employers, sole proprietors, corporations, partnerships, nonprofit
associations, trusts, estates of decedents, government agencies, certain
individuals, and other business entities.

Appendix I: Scope and Methodology Page 33 GAO- 02- 943 Private Pensions

To address the implications of investing in employer securities, we
identified companies whose pension plans were heavily invested in
company*s securities. We specifically looked for companies where employees
have experienced substantial retirement losses similar to Enron and ones
where the employees have benefited. Given the sensitivity and nature of
our review, it was difficult to find companies that would speak with us
and share their plans* investment experiences, whether good or bad.
However, we were able to find officials in two companies that were willing
to discuss their pension plan and experiences.

To identify and describe the implications of companies where employees
have experienced significant losses due to bankruptcy or declines in the
market valuations of the company*s stock, we obtained information about
the company*s history and pension plans through U. S. news, trade industry
reports, business journals, and company Web sites. We researched fraud
cases on the world wide web; reviewed legal briefs and opinions outlining
the details of lawsuits filed against the companies; and reviewed
bankruptcy filings and proceedings to describe the history of events that
lead the company to seek bankruptcy protection.

To identify and describe situations where employees have not experienced
significant losses, we interviewed two companies whose private pension
plans are heavily invested in company securities. We developed a set of
structured interview questions to obtain information about the companies,
specifically background information and information about the company*s
pension plans. We also reviewed and analyzed the company*s summary plan
descriptions and prospectus to determine how the plans were administered
and to identify requirements and restrictions of each plan.

To report on the regulatory provisions for disclosures to participants
owning employer stock through their employer- sponsored plans, we reviewed
relevant laws and regulations and spoke with agency and industry
officials. In order to understand the regulatory provisions for
securities, we reviewed the Securities Act of 1933 and the Securities Act
of 1934. Similarly, we reviewed ERISA and 404( c) regulations to under
disclosure requirements for pension plans. We also reviewed past reports
on private pension plans, ERISA, Employee Stock Ownership Plans (ESOPs),
and issues regarding investment education and advice. We also spoke with
Department of Labor (DOL) pension and legal experts and officials from the
Securities and Exchange Commission*s Market Regulation Division, Investor
Education Division, Corporate Finance Division, and the Enforcement
Division. Implications of

Investing in Employer Securities

Regulatory Provisions for Disclosures

Appendix I: Scope and Methodology Page 34 GAO- 02- 943 Private Pensions

In order to determine the types of disclosures companies were providing to
plan participants, we spoke with officials from the American Benefits
Council, 401( k) Profit Sharing Council of America, the ESOP Association,
the ERISA Industry Committee, the American Society of Pension Actuaries,
the Investment Company Institute, and retirement plan administrators and
financial service providers.

To determine whether the SEC should reconsider its administrative
determination not to explore application of the Securities Act and the
Securities Exchange Act to defined contribution plans, we first researched
what SEC*s determination had been and second determined whether SEC
planned to reconsider its determination. We researched the relevant legal
history and SEC*s position papers. We reviewed relevant securities laws,
SEC regulations, and public SEC statements, as well as pertinent legal
matters. We interviewed and discussed SEC*s position on the application of
the Securities Act and the Securities Exchange Act to defined contribution
plans with SEC*s legal counsel and appropriate SEC staff.

Appendix II: Bankruptcy and Legal Proceedings of Companies Whose Employees
Participated in Employer- Sponsored Plans

Page 35 GAO- 02- 943 Private Pensions

Enron was engaged in the business of providing natural gas, electricity,
and communications to wholesale and retail customers. Only months before
its bankruptcy filing, the company was regarded as one of the most
innovative, fastest growing, and best managed businesses in the United
States. However, Enron*s problems did not arise in its core energy
operations, but in other ventures, particularly *dot com* investments in
Internet and communications businesses and in certain foreign
subsidiaries. Rather than recognize these problems, the company assigned
business losses to unconsolidated partnerships and other vehicles, which
reportedly inflated its income. 1 On December 2, 2001, the Enron
Corporation filed for Chapter 11 bankruptcy protection.

The decline in Enron*s stock price and its subsequent failure
substantially reduced the value of many of its employees* retirement
accounts. Under Enron*s 401( k) type plan, participants were allowed to
contribute from 1 to 15 percent of their eligible base pay in any
combination of pre- tax salary deferrals or after- tax contributions
subject to certain limitations. Participants were immediately fully vested
in their voluntary contributions. 2 Enron generally matched 50 percent of
all participants* pre- tax contributions up to a maximum of 6 percent of
all employee*s base pay, with matching contributions invested solely in
the Enron Corporation Stock Fund. Participants were allowed to reallocate
their company matching contributions among other investment options when
they reached the age of 50.

On April 8, 2002, a class action suit was filed on behalf of the plan
participants representing 24,000 current and former Enron employees who
participated in Enron*s plans. The lawsuit alleges that the Enron
Corporation Savings Plan Administrative Committee and other persons
responsible for safeguarding the assets of the employee*s plans are liable
for breaching their fiduciary duties under ERISA. In addition, the
Department of Labor (DOL) has opened an investigation to determine whether
there were any ERISA violations in the operation of the company*s employee
benefit plans. DOL also reached an agreement with Enron to appoint an
independent fiduciary to assume control of the

1 In late 2001, Enron revealed it would incur losses of at least $1
billion and would restate its financial results for 1997, 1998, 1999,
2000, and for the first quarters of 2001, to correct errors that inflated
Enron*s net income by $586 million.

2 Employees hired after July 1999 are fully vested in their company
contributions after 1 year of service. Appendix II: Bankruptcy and Legal

Proceedings of Companies Whose Employees Participated in Employer-
Sponsored Plans

Enron

Appendix II: Bankruptcy and Legal Proceedings of Companies Whose Employees
Participated in Employer- Sponsored Plans

Page 36 GAO- 02- 943 Private Pensions

company*s retirement plans. SEC had not taken any enforcement actions as
of August 1, 2002. 3

Color Tile*s financial problems began as a result of a 1993 business
transaction that left the company undercapitalized, without the ability to
service its debts and operate in a competitive fashion. In 1995, the
company defaulted on a $10.4 million interest payment, forcing the company
to seek relief under Chapter 11 of the bankruptcy code. In 1996, after 44
years in the floor- covering business and failing at several attempts to
remain competitive in a changing flooring market, Color Tile sought
Chapter 11 protection. One day after filing for bankruptcy protection, the
company closed 234 of its 621 company- owned stores nationwide. After
several attempts to save the company, Color Tile closed the remaining of
its stores a year later affecting some 3,900 employees. Company executives
blamed its financial troubles on slow flooring sales and competition from
other centers.

In 1996, a former Color Tile employee sued Color Tile, alleging
mishandling of the plan assets, including investing the plan assets in
Color Tile property. The employee won, and the settlement required the
plan trustee and fiduciary carrier to pay about $4 million to Color Tile*s
$34 million 401( k) plan. In 1993, DOL investigated Color Tile and found
no violations. SEC did not open an investigation of Color Tile.

The company began to experience financial difficulties as a result of a
failed 1987 leveraged buyout. The value of the company*s stock declined,
and the company found itself under $4.9 billion of debt, which it had
incurred as the result of the 1987 leveraged buyout. In addition, the
company lost $1.3 billion and then suddenly ran out of money to pay the
interest on the debt, forcing the company to sell 58 of its convenience
stores to a Japanese retailer. Southland*s pension plans included a 401(
k)

3 SEC has taken few enforcement actions to date against companies
concerning their pension plans. SEC staff advised that the SEC had not
taken actions to safeguard or recover assets of retirement plans triggered
by situations where* in the last 10 years* employees have suffered
substantial losses because plans that held employer stock had declined in
value or had limited employees* ability to diversify investments or sell
company stock. According to SEC staff, these matters do not deal with
disclosure or registration issues that are under SEC*s authority. Instead,
these matters are more related to the merits of the plans and how they
operate under ERISA, thus, falling under DOL*s regulatory authority. Color
Tile

Southland

Appendix II: Bankruptcy and Legal Proceedings of Companies Whose Employees
Participated in Employer- Sponsored Plans

Page 37 GAO- 02- 943 Private Pensions

plan and a profit- sharing plan. Fifty- eight percent of the assets in
Southland*s 401( k) plan was used to buy 1,100 7- Eleven stores and then
leased back to the company. After its bankruptcy, Southland reduced its
holdings in 7- Eleven stores to 46 percent of Southland*s 401( k) plan
assets.

In 1991, Southland*s Japanese partners acquired 70 percent of Southland*s
common stock for $430 million. The cash infusion allowed the company to
emerge from bankruptcy with its debt load reduced by 85 percent. Southland
emerged from bankruptcy protection on March 5, 1991.

Lucent Technology, which spun off from AT& T in 1996, at one time held a
dominant position in the telecommunications equipment market. During the
first quarter of fiscal year 2000, the company*s revenues began faltering
as a result of the company*s inability to develop and deliver new products
as the market required. In addition, Lucent developed problems with AT& T,
its largest and most important customer. As a result, Lucent shares began
falling in January 2000, when the company said its fourth- quarter profits
would fall short. In subsequent quarters, the company kept cutting
forecast and the shares kept plunging. Between December 31, 1999, and July
2001, Lucent shares declined from $70 to $6. In fiscal year 2001, Lucent
posted a $16 billion loss and anticipated a large- scale layoff.

Employer contributions to Lucent*s management 401( k) plan were made in
the form of employer stock. For nonmanagement employees, about one- third
of the Lucent*s workforce, the employer 401( k) match was in the form of
an ESOP contribution made in employer stock. It is not clear to what
extent participants were able to diversify their employer contributions.
With some 30 percent of the company*s 401( k) plan invested in company
stock, employee account balances declined when Lucent*s stock price fell.

The collapse of Lucent*s stock sparked a class- action lawsuit by Lucent
employees whose 401( k) accounts suffered losses. The suit alleges that
Lucent breached its fiduciary duty for allegedly failing to inform
employees that investing in Lucent stock was imprudent. The lawsuit also
alleges that Lucent executives knew the company*s business was
deteriorating, but continued to encourage participants and beneficiaries
to make and maintain substantial investments in company stock. The case is
currently pending the in the courts. SEC had not taken any enforcement
actions as of August 1, 2002. Lucent

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 38 GAO- 02- 943 Private Pensions

The federal securities laws regulate the securities markets, the companies
issuing securities, and market participants. The securities laws can
relate to employee benefit plans in several ways. The interests of
employees in the plan itself can be securities, or the plan may invest in
instruments that are securities, such as stocks, bonds or interests in
mutual funds. Finally, the plan may have investments in collective
investment vehicles such as interests in pooled investment funds, bank
common and collective trust funds, or insurance company pooled separate
accounts.

In most cases, participation interests in pension and profit- sharing
plans 1 are not required to register under the Securities Act of 1933
(1933 act). Registration is not required unless participation in the plan
is voluntary and employee contributions can be used to purchase employer
securities. Thus where a plan includes a 401( k) arrangement and employees
can choose to invest in employer securities through voluntary salary
reductions or deferrals, participation interests will be securities.
Pension and profit- sharing plans that are required to register are
permitted by SEC to use an abbreviated registration form and may use
various documents, including a Summary Plan Description 2 as the
prospectus deliverable to employees.

The company securities offered to employees through such a voluntary and
contributory employee benefit plan must be registered under the 1933 act,
unless an exemption is available. These offerings qualify for an
abbreviated registration statement. Interests of plans in collective
investment vehicles are also securities, but may be exempt from
registration.

1 *Pension* and *profit sharing* plans are generally qualified under
S:401( a) of the Internal Revenue Code, and receive favorable tax
treatment. Qualified plans must satisfy coverage, participation, vesting,
and benefit accrual standards that are intended to ensure that plans are
established for the exclusive benefit of employees and prevent
discrimination in favor of highly compensated individuals. A pension plan
is established and maintained by an employer primarily to provide
systematically for the payment of definitely determinable benefits to its
employees over a period of years, usually for life, after retirement. 26
C. F. R. S:1.401- 1( b)( 1)( i). A profit- sharing plan is a plan
established by an employer to provide for participation in profits by
employees pursuant to a definite formula for allocating the contributions
and distributing accumulated funds. 26 C. F. R. S:1.401- 1( b)( 1)( ii). A
profitsharing plan is a defined contribution plan because the employer*s
contribution is set at a percentage of profits.

2 29 U. S. C. S:1021( a) requires the administrator of an ERISA plan to
furnish each plan participant a summary plan description. Appendix III:
SEC*s Application of the

Securities Laws to Retirement Plans

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 39 GAO- 02- 943 Private Pensions

The 1933 act requires the registration with the Securities and Exchange
Commission (SEC) of all offers and sales of securities, unless an
exemption from registration is available. The registration regime is based
on the premise that investors are protected if all relevant features of
the securities being offered are fully and fairly disclosed. Full
disclosure is believed to provide investors with sufficient opportunity to
evaluate the merits of an investment. A registration statement that meets
the 1933 act*s disclosure requirements must be filed, unless one of the
exemptions under section 3 or 4 of the 1933 act is available. The 1933 act
also prohibits the use of fraud or misrepresentation in the offer or sale
of a security, whether or not registration is required.

Section 2( a)( 1) of the 1933 act contains a broad definition of security,
which includes any note, stock, treasury stock, bond, debenture, evidence
of indebtedness, certificate of interest, or participation interest in an
investment contract. 3

The Securities Exchange Act of 1934 (Exchange Act) also imposes
registration and reporting requirements upon issuers of certain
securities. These requirements keep shareholders and markets informed
about the issuer. Section 12( a) of the Exchange Act requires that all
securities traded on a national exchange be registered with the SEC. 4 The
Exchange Act also requires an issuer to register if it has a class of
equity securities held by more than 500 shareholders of record and more
than $10 million in total assets. 5 An issuer with a class of registered
securities must file periodic reports, including quarterly and annual
reports.

3 17 U. S. C. S: 77b( a)( 1). 4 15 U. S. C. S: 78l( a). 5 15 U. S. C.
S:78l( g)( 1); 17 C. F. R. S:240.12g- 1. Registration

Requirements Under the Securities Act and the Exchange Act

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 40 GAO- 02- 943 Private Pensions

With respect to the definition of security, the Supreme Court in SEC v. W.
J. Howey Co. determined that *an investment contract for the purposes of
the 1933 act means a contract, transaction or scheme whereby a person (1)
invests his money (2) in a common enterprise and (3) is led to expect
profits (4) solely from the efforts of a promoter or a third party.* 6

In International Brotherhood of Teamsters v. Daniel, 7 the Supreme Court
found that an interest in a compulsory (all employees automatically
participate), noncontributory (the employer makes all the contributions)
defined benefit employee pension plan is not a security under the 1933
act*s definition. In determining that the interest in the plan did not
meet the commonly understood definition of an investment contract, the
Court focused on the factors set out in the Howey test. First, the Court
found that an employee who participates in a noncontributory, compulsory
pension plan makes no payment into the pension plan, and the employer*s
payments into the plan do not relate to the individual benefit received by
employees. Therefore, the investment portion of the Howey test is not
satisfied in the case of a defined benefit plan. In addition, the Court
found that because a major part of the retirement benefits were to be
derived from the employer*s contributions, rather than from the efforts of
the plan*s managers in investing the income, the plan did not have
sufficient profit aspects to fall within the test for an investment
contract in Howey.

The Court also pointed out that the fact that ERISA comprehensively
governs the use and terms of employee pension plans severely undercuts all
arguments for extending the securities laws to noncontributory, compulsory
pension plans. The Court explained that ERISA regulates the substantive
terms of pension plans, setting standards for plan funding and limits on
the eligibility requirements an employee must meet as well requirements
for disclosure of specified information in a specified manner.

6 328 U. S. 293, 298- 99 (1946). 7 439 U. S. 551( 1979). The U. S. Supreme
Court

Has Determined That an Employee*s Interest in an Involuntary,
Noncontributory Retirement Plan Is Not a Security

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 41 GAO- 02- 943 Private Pensions

In 1941, the SEC first stated its view that employee interests in pension
and profit sharing plans generally are securities, but did not require
registration of interests in the plans unless the plan provided for
purchase of the employer*s stock. 8 In SEC*s view, the burden of preparing
a registration statement in connection with a pension plan could result in
many employers not sponsoring pension plans. However, a registration
requirement is justified if employer stock can be purchased, because the
employer has a direct financial interest in the solicitation of employees*
contributions. This conclusion was based on the view that where employer
stock is among the investment options, *it is not unfair to make the
employer assume the same burdens which corporations typically assume when
they go to the public for financing.* According to the Supreme Court*s
opinion in the Daniel case, after 1941, SEC made no further efforts to
register plan securities other than voluntary, contributory plans where
the employees* contributions were invested in the employer*s securities.

Subsequent to the Daniel decision, the SEC issued two major interpretive
releases, 9 the first of which set forth views on when a participation
interest in a pension plan is an investment contract and thus a security.
Release No. 6188, dated February 1, 1980, reiterated the SEC*s view that,
while employee interests in pension plans generally are securities,
employee interests should be registered only when the plan is both
voluntary and contributory and may invest in stock of the employer an
amount greater than that paid into the plan by the employer. The release
defines a *voluntary* plan as one in which employees may elect whether or
not to participate, and a *contributory* plan as one in which employees
make direct payments, usually in the form of cash or payroll deductions.

This administrative practice is based on the SEC*s opinion that (1)
registration serves no purpose where a plan is involuntary, since in that
situation the participant is not permitted to make an investment decision,
and (2) the costs of registration are a significant burden to an employer
and should be imposed only where the employer has a direct financial
interest in soliciting voluntary employee contributions.

8 Opinion of Assistant General Counsel, CCH Fed. Sec. L. Rep. [1941- 1944
Transfer Binder], para. 75,195. 9 An interpretive release sets forth the
views of the SEC or its staff on questions of current concern, without
stating them in the form of legal requirements. They are general public
statements of policy. SEC*s Position That

Interests in Voluntary Contributory Plans Are Securities and Must Be
Registered if Employee Funds Can Be Used to Purchase Employer Stock Is
Reiterated in Interpretive Releases

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 42 GAO- 02- 943 Private Pensions

The 1980 release found that voluntary, contributory plans where an
employee is permitted to invest in employer securities met the four parts
of the Howey test defining an investment contract. First, the payment of
cash or its equivalent by an employee satisfies the *investment*
requirement. Second, the *common enterprise* requirement is met where the
interests of employees in the plan are *separable* and possess
*substantially the characteristics of a security.* In both defined
contribution and defined benefit plans, there is a separate account
maintained for each participant to the extent of each person*s
contribution to the plan. Third, the *expectation of profits* requirement
is met when the employee voluntarily contributes his or her own funds to
the plan and can expect that the funds will generate profits through the
efforts of the plan managers. In the Daniel case, the Court suggested that
unless a defined benefit plan has a substantial dependence on earnings, as
well as vesting requirements that are not excessively difficult to
satisfy, there might be no expectation of profits. The 1980 release
stated, however, that a voluntary, contributory defined benefit plan could
meet the expectation of profits test because it may depend on earnings to
pay promised benefits and because the vesting requirements under ERISA are
much less strict than the requirement that was present in the Daniel case.
Finally, the 1980 release stated that the *from the efforts of others*
test was easily satisfied because the earnings generated by a plan would
result from the efforts of the plan managers.

SEC*s analysis concluded that the interests of employees in voluntary,
contributory pension plans are securities within the meaning of the 1933
act. The staff also concluded that the interests are offered and sold to
employees within the meaning of the 1933 act. Consequently, the interests
are subject to registration requirements unless one of the exemptions from
registration applies. Antifraud laws apply to all sales of securities.

Section 3 of the 1933 act exempts various types of securities from the
registration requirements, generally based on the nature of the issuer and
the terms of the security. The statutory exemptions apply to the 1933
act*s registration requirements, but do not apply to prevent potential
liability under the antifraud provisions.

Section 3( a)( 2) of the 1933 act exempts collective funding vehicles
maintained by banks and insurance companies for employee benefit plans
Most Types of Pension

Plans Are Exempt from Registration under Section 3( a)( 2) of the 1933 Act

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 43 GAO- 02- 943 Private Pensions

and the interests of employees in qualified plans, unless any employee
funds can be used to purchase employer securities. 10 In addition, if the
plan does not restrict the plan*s overall investment in employer
securities so that it cannot exceed the employer*s contribution, the
exemption is not available, and the interests offered by the plan must be
registered. 11 Under the SEC*s analysis, registration will generally be
required in connection with any plan that permits contributions from
participants and permits all or any portion of these contributions to be
applied to the purchase of employer stock. The SEC*s view that the 3( a)(
2) exemption extends to pension plans is based on its reading of the
legislative history of the provisions and its view that the section should
be given a broad interpretation so as to exempt most plans.

On January 15, 1981, the SEC issued Release No. 33- 6281, an interpretive
release providing further guidance on the application of the 1933 act to
employee benefit plans. In the 1981 release, the staff expanded on the
definition of a voluntary, contributory plan, explaining that the
determination of whether a plan is voluntary and contributory depends
solely on whether participating employees can decide at some point whether
or not to contribute their own funds to the plan. The release also
discussed the amendments to the section 3( a)( 2) exemptions made by the
Small Business Investment Incentive Act of 1980. The 1980 amendments
broadened the scope of the exemption by including certain insurance
contracts and governmental plans within its coverage. In addition, the
amendments make clear that any security arising out of a contract with an
insurance company will be exempt under section 3( a)( 2) in connection
with a plan specified in the section.

In the 1981 release, the staff also discussed cash or deferred
arrangements qualifying under section 401( k) of the Internal Revenue
Code. Arrangements considered in the 1981 release allowed employees to
elect to receive immediate payment of the employer*s plan contribution or
to defer receipt and have it invested in a plan where it will accumulate
for

10 In the Daniel decision, the Supreme Court read the 3( a)( 2) exemption
to refer only to the plan*s interest in the investment vehicle. SEC*s view
that the exemption also applies to interests of participants in the plans
themselves is based on its reading of the exemption*s legislative history
and the practical consideration that many plans would have no exemption
without a broad interpretation.

11 Comdial Corporation, SEC No- Action Letter, available May 28, 1984. A
*no action letter* is an SEC staff response to private requests for an
indication that certain contemplated transactions will not trigger SEC
enforcement action.

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 44 GAO- 02- 943 Private Pensions

later repayment. The staff determined that these arrangements are not
contributory on the part of employees because they did not involve out-
of- pocket investments by employees of their own funds in employer stock.
Instead, the plans are funded by employer contribution.

However, subsequent to the 1981 release, the Treasury Department issued
rules 12 under section 401( k) that allowed plans to provide for pre- tax
employee contributions through salary reduction. In a salary reduction
plan, the employee elects to reduce his compensation and have the amount
contributed to a plan. This type of salary reduction is considered to be
an out- of- pocket contribution into the plan. Because such a plan is
voluntary and contributory, plan interests would be securities.
Registration of 401( k) plan interests in a salary reduction plan would be
required if employee contributions are permitted to be invested in
employer stock. 13

Other Securities Act exemptions may apply to offers and sales of employer
securities. In 1988, SEC adopted Rule 701 to exempt from 1933 act
registration employee plans of employers that are not subject to the
Exchange Act*s periodic reporting requirements. Rule 701 is available to a
number of types of employee benefit plans. 14 During a 12- month period,
an offering may be exempt for an amount up to the greatest of $1 million,
15 percent of the total assets of the issuer, or 15 percent of the
outstanding amount of the class of securities being offered and sold in
reliance on section 701. Securities acquired under a Rule 701 offering are
treated as restricted securities and may not be resold unless the 1933
act*s registration requirements are complied with or unless another
exemption applies.

12 Certain Cash or Deferred Arrangements Under Employee Plans, 46 F. R.
55544, (Nov. 10, 1981). A 401( k) feature can be appended to a qualified
plan. The Treasury regulations refer to 401( k) features as *qualified
cash or deferred arrangements.* The cash or deferred arrangement can be in
the form of a salary reduction agreement between an employee and the
employer under which a contribution will be made only if the employee
elects to reduce his compensation or to forgo an increase in his
compensation. 26 C. F. R. 1.401 (k)- 1( a)( 3)( i).

13 Diasonics, Inc., SEC No- Action Letter, available December 29, 1982. 14
17 C. F. R. S:230. 701. The Rule 701 exemption applies to purchase plans,
option plans, bonus plans, stock appreciation rights, profit sharing,
thrift, incentive, or similar plans. Other Exemptions from

Securities Act Registration

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 45 GAO- 02- 943 Private Pensions

Private and limited offerings also are exempt whether or not the company
is subject to Exchange Act reporting. Under Section 3( b) of the 1933 act
15 SEC may adopt regulations exempting issuers in the amount of $5 million
or less. Under section 3( a)( 11), *intrastate* offerings are exempt from
registration where all aspects of the offering are within the confines of
one state and are purely local in nature. 16

Section 4( 2) 17 exempts transactions by an issuer not involving any
public offering. This exemption applies to offerings to sophisticated
institutional and individual investors who do not need the protections of
federal registration. In SEC v. Ralston Purina Co., 18 the Supreme Court
determined that an offering to employees was not necessarily exempt as not
involving a public offering. Ralston Purina made its stock available to
all employees regardless of their connection with the company or knowledge
of the business. Citing the design of the 1933 act to protect investors by
promoting full disclosure of information necessary to informed investment
decisions, the Court found that the employees were a class of persons that
needed the protection offered by registration because they were not able
to fend for themselves in connection with the transaction.

An ESOP is a defined contribution plan that invests primarily in employer
securities and usually distributes the securities upon the employee*s
retirement. Under SEC*s analysis, an employee*s interest in a voluntary,
contributory ESOP is a security. In Uselton v. Commercial Lovelace Motor
Freight 19 the Tenth Circuit held that an interest in a contributory and
voluntary employee stock ownership plan was a security and that ERISA did
not provide sufficient protection to displace the application of the
federal securities laws. However, an interest in a mandatory stock

15 15 U. S. C. S:77c( b). 16 15 U. S. C. S:77c( a)( 11). 17 15 U. S. C.
S:77d( 2). 18 346 U. S. 119 (1953). In more recent cases, the ability to
fend for oneself has been interpreted to mean that the persons to whom the
securities are offered must be *sufficiently sophisticated to demand and
understand the information that is available to them.* Thomas Lee Hazen, 1
Treatise on the Law of Securities Regulation 406 (4 th ed. 2002).

19 940 F. 2d 564 (10th Cir. 1991). Registration Requirements

That Apply to ESOPs

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 46 GAO- 02- 943 Private Pensions

ownership plan completely funded by the employer was held not to be a
security in Matassarin v. Lynch. 20

In May 1992, the SEC*s Division of Investment Management issued a study
entitled, *Protecting Investors: A Half Century of Investment Company
Regulation.* The study proposed that all pooled investment vehicles for
participant- directed defined contribution plans be required to deliver
prospectuses for the underlying investment vehicles to plan participants.
The study reviewed the legislative history of the 1970 amendments to
Section 3( a)( 2) of the 1933 act and found that the basis for the
exemption was concerns expressed by both the banking and insurance
industries that the lack of a clear exemption under the securities laws
for pooled investment vehicles might expose banks and insurance companies
to civil liabilities. Congress exempted these pooled investment vehicles,
in part, because they were subject to oversight by bank and insurance
regulators. The interests issued by the pooled investment vehicles in
question were still subject to the anti- fraud provisions of the 1933 act,
notwithstanding the amendments. In addition, Congress assumed that the
person making investment decisions for a plan (the sponsoring employer or
a professional investment manager) was a sophisticated investor able to
fend for itself with the application of only the 1933 act*s antifraud
provisions. The study highlighted, however, that since the passage of the
1970 amendments, the character of employee benefit plans has shifted from
defined benefit plans, in which the plan sponsor bears the investment
risk, to participantdirected defined contribution plans, in which the plan
participant bears the investment risk.

Finding that the information received by plan participants was far less
than the information received by investors who invest directly in
securities issued by investment companies and other issuers, the Division
of Investment Management expressed its view that disclosure to these plan
participants should be improved. It recommended that the SEC send to
Congress legislation that would: (i) remove the current exemption from
registration in Section 3( a)( 2) for interests in pooled investment
vehicles consisting of assets of participant- directed defined
contribution plans; and (ii) require delivery of the prospectuses and
other disclosure documents of the pooled investment vehicles (other than
mutual funds) to all plan participants.

20 174 F. 3d 549 (5th Cir. 1999). A 1992 Study Recommends

Disclosure to Plan Participants Who Make Their Own Investments in Pension
Plans

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 47 GAO- 02- 943 Private Pensions

Subsequent to the issuance of the study, the DOL issued voluntary rules
under Section 404( c) of ERISA that provide plan fiduciaries with a safe
harbor from liability under certain conditions when plan participants
exercise control over the assets in their individual accounts. One of the
rule*s specific guidelines allowing fiduciaries of participant- directed
plans potentially to avoid fiduciary liability is that plan participants
who invest in securities that are subject to the 1933 act receive at or
about the time of a participant*s initial investment in the securities a
copy of the issuer*s most recent prospectus. 21 In general, the guidelines
obligate the plan sponsor to provide or make available to plan
participants sufficient information so that they may make informed
investment decisions. While the disclosures required by the 404( c) rules
generally make more information available to plan participants by
encouraging plan sponsors to provide or make available more information
about the underlying investment options offered by the plan, the view of
the Division of Investment Management is that plan participants have a
continuing need for information in order to evaluate their investments,
and decide whether to maintain or reallocate those investments.
Accordingly, the approach of the Division of Investment Management would
go farther by requiring delivery to plan participants of a current mutual
fund prospectus on a continuing basis as well as delivery of annual and
semi- annual shareholder reports by mutual funds and other underlying
investment vehicles. 22

If Securities Act registration of employee*s interests in an employee
benefit plan is required, then Form S- 8 is generally the appropriate form
for use. Form S- 8 is also used for registering employer securities issued
in connection with employee benefit plans. Form S- 8 is available only if
the employer is subject to the Exchange Act reporting requirements. Form
S- 8 utilizes an abbreviated disclosure format that reflects the SEC*s
distinction between offerings made to employees primarily for compensatory
and incentive purposes and offerings made by registrants for capital-
raising purposes. The SEC has exercised its rule- making authority to
reduce the

21 Final Regulations Regarding Participant Directed Individual Account
Plans (ERISA Section 404( c) Plans) 29 C. F. R. S:2550.404c- 1. 22 Mutual
funds must send semiannual reports to their shareholders. These reports
are required to include information concerning the investments* aggregate
value, a listing of amounts and values of securities owned; an itemized
income statement; a statement of the remuneration paid to all directors
and members of an advisory board. In addition, SEC applies certain
requirements to the mutual fund prospectus, including a requirement that
mutual funds provide shareholders with after- tax performance information.
Interests in Employee

Benefit Plans That Are Securities May Be Registered Using Form S- 8

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 48 GAO- 02- 943 Private Pensions

costs and burdens incident to registration of employee benefit plan
securities.

The SEC substantially revised Form S- 8 in 1990. 23 The revisions included
making the registration statements effective automatically upon filing. 24
A prospectus is customarily part of a registration statement, and contains
the basic business and financial information about the issuer with respect
to a particular securities offering. Investors use the prospectus to
appraise the merits of the offering and make educated investment
decisions. However, Form S- 8 is the only registration form that does not
require the registrant to prepare and file with the SEC a separate
document to satisfy the prospectus delivery requirements under the federal
securities laws. Instead, Form S- 8 requires only that certain specified
current plan information be delivered to employees in a timely fashion. No
particular legal format is specified. The information could be provided in
one or more documents prepared in the ordinary course of employee
communications. Registrants can deliver materials required to be prepared
for plan participants by ERISA and could deliver the Summary Plan
Description as a basic disclosure document. 25 The issuer must also supply
participants with a written statement that certain documents are
incorporated by reference into the prospectus, and advise the participant
of their availability on request. These documents include the Exchange Act
filings containing issuer information and financial statements.

At the same time, the SEC also permitted 1933 act registration of an
indeterminate amount of plan interests; simplified the calculation of
filing fees; and amended Form 11- K, the Exchange Act annual report for
employee benefit plans, to require only plan financial statements.

23 See Release No. 33- 6867 (July 13, 1990). 24 A registration statement
is generally effective twenty days after the later of the filing of the
initial registration statement or the most recent amendment to the
registration statement.

25 Release No. 33- 6281, pt. IV (C) outlines staff interpretive positions
regarding the incorporation by reference in a Form S- 8 prospectus of plan
information contained in an ERISA summary plan description.

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 49 GAO- 02- 943 Private Pensions

Section 12( g) of the Exchange Act 26 requires that registration
statements be filed by issuers that have both a class of equity securities
having more than 500 shareholders of record and more than $10 million in
total assets. Companies must register their stock and satisfy all
reporting requirements of the Exchange Act if these criteria are met. For
purposes of determining the number of record holders of a class of
securities, an employee benefit plan holding employer securities is
counted as only one record holder. 27 If the employer*s securities must be
registered under the Exchange Act, the employer will incur periodic
reporting obligations, including annual and quarterly reports, as well as
filings reporting certain specified material changes in the issuer*s
condition or operations.

If the interests of the plan participants are considered securities, the
plan may be subject to registration under the Exchange Act. However,
interests in qualified plans are exempt from registration under the
Exchange Act because Rule 12h- 1 exempts from registration all interests
in employee stock bonus, stock purchase, pension, profit sharing,
retirement, incentive, or similar plans that are not transferable by the
employee.

Employee plans that are owners of securities that are registered under the
Exchange Act may be subject to different Exchange Act reporting
requirements. A plan that becomes the beneficial owner of more than 5
percent of a class of equity securities registered under the Exchange Act
must file a report with the SEC on Schedule 13G. 28 When a plan acquires
stock for the benefit of officers and directors of an employer, the
officers and directors are required to follow the Section 16 reporting
requirements. Transactions of these company insiders may be subject to the
short swing profit recovery rules if the insider switches into or out of
an employer stock fund or takes a cash distribution from the fund in a
*discretionary

26 15 U. S. C. S:78l( g). 27 Rule 12g5- 1( a)( 2). Of course, the number
of beneficial owners (plan participants) will be far more numerous. 28 The
reporting requirement is intended to notify SEC of a potential change in
control, however, because employee plans are not the beneficial owners of
securities, they may qualify for an abbreviated reporting requirement.
Rule 13d- 1( b)( 1)( ii)( F) permits employee benefit plans subject to the
provisions of ERISA to file the short- form 13G if the securities are
acquired in the ordinary course of business and not with the purpose or
effect of changing the control of the issuer. Beneficial ownership is
defined as the power to vote and/ or exercise investment power over the
security. 17 C. F. R. S:240. 13d- 3. Defined contribution plans generally
pass through voting rights. Registration and

Reporting Requirements Under the Securities Exchange Act

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 50 GAO- 02- 943 Private Pensions

transaction* if the transaction occurs less than 6 months after any
previous *opposite way* transaction. 29

Section 10( b) of the Exchange Act 30 prohibits the use of any
manipulative or deceptive practices in connection with the purchase or
sale of a security. Rule 10b- 5 31 makes it unlawful for any person to
make a material misstatement or omission in connection with the purchase
or sale of a security. Section 10( b) and Rule 10b- 5 will apply to
material misrepresentations and omissions made to plan participants in
connection with plan transactions that involve securities. Violations of
Rule 10b- 5 can be asserted by plan participants if the plan is making
material misstatements or omissions in the materials the plan provides to
participants in connection with a sale of company stock to plan
participants. Rule 10b- 5 can also apply to the purchase or sale of a
security on the basis of material nonpublic information about that
security in breach of a duty of trust or confidence. 32 This could apply
where an officer or director buys or sells shares through a plan and was
aware of material non- public information when the transaction took place.

Section 17( a) of the 1933 act 33 prohibits fraud, material misstatements
and omissions of fact in connection with the sale of securities. Section
17( a) applies whether the sale is registered or exempted from the 1933
act registration. Neither section 17( a) nor Exchange Act Rule 10b- 5
imposes an affirmative duty to disclose, but can impose liability for
omissions that make statements materially misleading.

29 Section 16( b) of the Exchange Act requires insiders to disgorge to the
company any profit realized from a short swing transaction. A
discretionary transaction is generally at the volition of the participant.

30 15 U. S. C. S:78j( b). 31 17 C. F. R. S:240. 10b- 5. 32 Rule 10b5- 1
defines *on the basis of* to mean the person making the purchase or sale
was aware of the material nonpublic information when the person made the
purchase or sale. However, Rule 10b5- 1( c ) establishes conditions
whereby a person*s purchase or sale is not *on the basis of* material non-
public information if another person is instructed to make the purchase or
sale for the instructing person*s account and at the time of the original
instruction the instructor was not aware of the material nonpublic
information. This could include a situation where a person enrolls in a
plan and agrees to have a payroll deduction invested in employer
securities.

33 15 U. S. C. S:77q( a). Anti- fraud Rules

Applicable to Employee Benefit Plans

Appendix III: SEC*s Application of the Securities Laws to Retirement Plans

Page 51 GAO- 02- 943 Private Pensions

Historically, SEC has taken the position that interests in employee
benefit plans can be securities for purposes of the 1933 act requirements
to register offers and sales of securities. However, SEC has taken the
view that offers and sales of plan interests are not subject to
registration unless the plan allows employee funds to be used to purchase
employer stock. In 1979, the U. S. Supreme Court decided that interests in
plans where employees had no choice concerning participation and where
employees did not make contributions to the plan were not securities and
did not have to be registered. In the wake of the Supreme Court*s
decision, SEC issued two releases indicating that only voluntary,
contributory plans where employee funds could be invested in employer
stock would be required to file registration statements.

SEC*s position is based, in part, on its interpretation of the
registration exemptions contained in section 3( a)( 2) of the 1933 act. In
SEC*s view, in light of the Daniel opinion, the 3( a)( 2) exemption
applies to all qualified employee plans, except those that allow the use
of employee funds to purchase employer stock. While SEC*s 1980 release
indicated that it did not favor a broader registration requirement, this
release was issued when the prevalent plan was a defined benefit plan. SEC
has not reconsidered its position as expressed in this 1980 release and
believes it is bound by the Supreme Court*s decision in Daniel.

Conclusion

Appendix IV: Comments from the Department of Labor

Page 52 GAO- 02- 943 Private Pensions

Appendix IV: Comments from the Department of Labor

Appendix IV: Comments from the Department of Labor

Page 53 GAO- 02- 943 Private Pensions (130114)

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